Keywords

Classification

Innovation and strategy

Definition

Creative destruction describes the revolutionalizing process in which a new product, process, or method replaces the old; in other words, it describes the process of how capitalist economic development occurs based on the destruction of prior institutional, business, and market structures. What makes capitalism distinctive is the decentralized and distributed capacity for introducing new patterns of behavior; whether they are technological, organizational or social, they are the fuel that drives economic change (Metcalfe 1998, p. 3). Entrepreneurs building new companies are often the instrument of creative destruction; incumbent firms are usually the victim.

The term “creative destruction” is often attributed to Austrian American economist, Joseph Schumpeter, who viewed the term as “the essential fact about capitalism.” He believed that the process of creative destruction is at the core of economic growth. In Capitalism, Socialism, and Democracy, Schumpeter (1942) wrote:

The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as U.S. Steel illustrate the same process of industrial mutation – if I may use that biological term – that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. (Schumpeter 1942: 83)

Schumpeter’s description of capitalism as “the perennial gale of creative destruction” has been influential in our understanding of how economies evolve. “The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process,” Schumpeter wrote (p. 82). Economic progress is not a simple linear growth process, but it is characterized by a non-linear process in which new firms invent new products and processes which displace older products and processes and the firms that make them.

Schumpeter’s view of the economic world stands in stark contrast with the static equilibrium model prevailing in economics during Schumpeter’s years. These neo classical approaches contain no provision for innovation, entrepreneurship, and technology. Schumpeter does not assume that markets tend toward equilibrium, but instead that entrepreneurs and technologies create disequilibrium, which leads to new profit opportunities. Schumpeter highlights the inability of static equilibrium analysis to capture the essential long-term features of capitalist reality (Rosenberg 2013, p. 7).

Schumpeter also viewed innovation as the engine of growth, and recognized that innovation is endogenously generated by profit-seeking firms. However, he viewed innovation in the narrow sense (“revolution from within the economic system”) also providing the fuel for the creative destruction process. That is, innovations destroy existing industry structures and result in new industry structures. Entrepreneurship and competition facilitate creative destruction. Schumpeter summed it up as follows:

The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates. (p. 83)

Schumpeter Versus Marx

While the term ‘Creative destruction’ has often been attributed to Joseph Schumpeter (1942), the idea perhaps originated from Marx as discussed in the work of Werner Sombart. Schumpeter also discussed Marx’s thought at length in Capital, Socialism and Democracy (1942). Although Marx didn’t explicitly use the term “creative destruction,” in the Communist Manifesto by Marx and Engels (1848), creative destruction is implied in the processes of the accumulation and annihilation of wealth under capitalism. Marx further developed the idea in Grundrisse (1857) and Das Kapital (1863). Marx and Engels (1848) described the crisis tendencies of capitalism in terms of “the enforced destruction of a mass of productive forces.” As Marx expressed it in the Communist Manifesto, the bourgeoisie “has played a most revolutionary role in history.” Capitalism,

It cannot exist without constantly revolutionizing the instrument of production, and thereby the relations of production, and with them the whole relations of society. The need of a constantly expanding market for its product chases the bourgeoisie over the whole surface of the globe. The bourgeoisie, by the rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all nations, even the most barbarian, into civilization. The bourgeoisie, during its rule of scarce 100 years, has created more massive and more colossal productive forces than have all preceding generations together. (Marx and Engels 1976, pp. 487–89)

Marx and Shumpeter both share “a vision of economic evolution as a distinct process generated by the economic system itself” (Clemence 1951: 160). Marx, no less than Schumpeter, perceived capital accumulation to occur irregularly, in bursts, with cyclical consequences (Marx 1906, pp. 672, 693–94).

Schumpeter and Marx shared a common vision, including the inherent instability of capitalism and the inevitability of “crises”, and the eventual destruction of capitalist institutions and the arrival of a socialist form of economic organization as a result of the working out of the internal logic of capitalist evolution (Rosenberg 2011, p. 1215).

Although both Schumpeter and Marx highlight the discontinuous nature of the capitalist dynamic, the causality is different. Schumpeter views the individual entrepreneur’s initiative as the core driver for economic development and technological change (Foster 1983, p. 328). Schumpeter describes a broader process by which capitalism, through its “creative” success, leads on to its own “destruction” as an economic system and prepares the way – technologically, institutionally, and psychologically – for a socialist economic system to succeed and supersede it (Elliott 1980).

However, in Marx’s view, the structure of accumulation itself establishes the important source of capitalist development (Foster 1983, p. 328). To put the matter briefly, Marx creates his model of stationary equilibrium (simple reproduction) by “assuming away” accumulation but not the capitalist, while Schumpeter’s model of the circular flow abstracts from the existence of the entrepreneur himself (Foster 1983, p. 328).

Examples

A classic example of Schumpeterian creative destruction is the introduction of the personal computer. The emergence of the personal computer introduced by then small firms such as Apple, Dell and HP made many of the industry’s leading minicomputer firms disappear. Incumbent computer manufacturers including DEC, Data General, Control Data, Prime Computer, and UNIVAC lost significant amounts of their value and employment while a new set of dominant players gained the value that previous leaders of their industry lost (Spencer and Kirchhoff 2006).

This pattern has happened in other industries. Christensen (1997) observes that even in the less technologically fast moving industries such as power shovels, the shift from cable to hydraulics left the industry with a new set of leaders while the old dominant players faded away. Similar effects are found in the typesetting (Tripas 1997) and digital imaging (Tripas and Gavetti 2000) industries.

The success of Netflix might be another example of creative destruction. Netflix has been so disruptive to existing industries that its impact is often referred to as the “Netflix effect.” Employment in the video/disk rental industry has decreased by 93% in a decade – from 153,000 jobs in 2005 to fewer than 11,000 in 2015 (Perry 2015).

The process of Schumpeterian can cause temporary economy-wide distress, such as loss of employment or income. Schumpeter acknowledges (1942) that displaced individuals might react with strong resentment:

Secular improvement that is taken for granted coupled with individual insecurity that is acutely resented is of course the best recipe for breeding social unrest (Schumpeter 1942, p. 145)…This type of reaction leads to the labor movement, and it is supported by intellectuals whose hostility increases with every achievement of capitalist evolution. (p. 154)

However, economists and policy analysts have concluded that such distress is an inherent part of economic growth, and that societies that allow creative destruction grow more productive and wealthy over time. For example, in 1900 almost 40 of every hundred Americans were farmers but in 2000, it took just two out of every hundred workers to feed America. Despite the decline in the number of farmers, the US is still a major agricultural exporter thanks largely to advances in agricultural productivity (Cox and Alm 2008).

Related Works in Economics and Management

Some economists and many management scholars, following Schumpeter, have long recognized the “disruptive” impact of innovation. As two Berkeley faculty noted 25 years ago:

The development, commercialization, and diffusion of product and process technologies have long been the most fundamental competitive forces in advanced industrial economies, generating economic growth, enhancing consumer welfare, and in the process, constantly challenging and frequently overturning the established order within and among industries. If one calibrates competition by the intensity of rivalry among industry participants, then innovation is unquestionably the major force driving competition. (Jorde and Teece 1993)

In the same vein, Abernathy and Clark (1985) developed the “transilience map” a framework analyzing innovations according to their effects on markets and competences. In their framework, they discussed disruptive innovations that disrupt markets and competencies. Bower and Christensen further develop this concept and note that disruptive technologies may not be ‘... radically new from a technological point of view’ but have superior ‘performance trajectories’ along critical dimensions that customers value (Bower and Christensen 1995; Christensen 1997).

Herbert Simon (1982) had a similar view of creative destruction by arguing that potential threats to a firm’s survival can lead to the change of routines. According to Simon’s model of satisficing behavior, firms maintain their routines as long as they can uphold satisfactory performance. Otherwise, they destroy their old routines and search for superior routines. Schumpeter would have disagreed with such a view of “creation” since Schumpeter views creation as an independent event rather than an adaptive response to pressures. Entrepreneurs’ innovative behaviors are individualistic and heroic actions, and it is the introduction of innovations into the old system that causes the destruction of old routines.

A version of the creative destruction thesis has entered the management literature and become immensely popular and influential in the form of Clay Christensen’s “Disruption Innovation” thesis (Christensen 1997). Christensen posits that Schumpeterian creative destruction follows particular pathways. He argues that incumbents have an advantage in serving the current customer base, but they get blindsided and fail to recognize the needs of new customers. New entrants arrive and disrupt incumbents, often by entering the market with cheaper and possibly lower performance products; but they eventually upgrade and win share from the incumbent. Implicitly, Christensen assumes that incumbents can effectively transform… but only if they put their mind to it. Failures are caused by bad management focusing on the immediate road ahead and not seeing challenges and opportunities that exist around the corners. Clearly, disruption is a syndrome that is common in highly competitive innovation driven markets.

Dynamic capabilities (Teece and Pisano 1994; Teece et al. 1997; Teece and Leih 2016) and disruption are related ideas, with dynamic capabilities being the more general framework that readily accommodates creative destruction/disruptive innovation. However, dynamic capabilities does not endeavor to predict the particular pathways by which innovators using new technology overturns the status quo and challenges incumbents. There remains much to be learned about particular contexts and strategies available to new entrants and to incumbents alike.

Utterback notes that Christensen’s concept is seductive due to the clarity of its examples and “its claimed power and generality” (Utterback and Acee 2003; Christensen et al. 2002). While recognizing the importance of the issues Christensen is addressing, Utterback goes on to summarize the Christensen thesis and then challenges it:

In Christensen’s theory of disruptive technology the establishment of a new market segment acts to channel the new product to the leading edge of the market or the early adopters. Once the innovation reaches the early to late majority of users it begins to compete with the established product in its traditional market.

And juxtaposed with his own research findings:

Here we have presented an alternative scenario in which a higher performing and higher priced innovation is introduced into leading established market segments and later moves toward the mass market. Diffusion for example, of fuel injection started with the luxury and sports car segments and then migrated into other segments. The first use of electronic calculators was in the scientific community. Later simpler, less expensive and portable models expanded the total market by creating new segments which later included the mass market. Cooper and Schendel similarly discuss the down-market progression of the ball point pen which was originally more expensive than the fountain pen. Continued development resulted in the “throw away” pen which opened up new market segments. (Acee 2001, p. 43)

The evidence would seem to suggest that there are multiple pathways by which innovation disrupts the status quo, as Utterback has documented. Innovation can also strengthen the status quo of incumbents as Tushman and Anderson (1986) has indicated and of complementors as Teece (1986, 2006, 2017Footnote 1) has suggested.

Interestingly, the management literature suggests that the problems of “disruption” (failure to respond to new technologies) is as much a decision making problem as it is a lack of capabilities. Cooper and Schendel (1976) noted half a century ago that:

…a typical sequence of events involving the traditional firm’s responses to a technological threat begins with the origination of a technological innovation outside the industry, often pioneered by a new firm. Initially crude and expensive, it expands through successive sub-markets, with overall growth following an S-shaped curve. Sales of the old technology may continue to expand for a few years, but then usually decline, the new technology passing the old in sales within 5 to 14 years of its introduction.

Cooper and Schendel conclude that failure to respond appropriately occurs because “decisions about allocating resources to old and new technologies within the organization are loaded with implications for the decision makers; not only are old product lines threatened, but also old skills and positions of influence.”

These observations drive home that responding to innovation driven competition requires a variety of strategies, depending on whether the innovation is competency destroying, or competency enhancing; and when it is the former, it’s not just a matter of upgrading capabilities. It’s also a matter of selecting the right projects, as the dynamic capabilities framework indicates.

See Also