Time to Face the Music
An explorative study of exiting firms in the Dutch music industry
University of Groningen, Faculty of Economics and Business
MSc. BA SIM
Supervisor: A.Geurts,
Co-assessor: K.McCarthy
Sebastiaan Phijffer (s2797518)
Zoutstraat 21a, 9712 TB, Groningen
26-06-2016
Word count:12872
Abstract
2 TABLE OF CONTENTS
INTRODUCTION ... 3
THEORETICAL BACKGROUND ... 5
Understanding disruption ... 5
Inhibitors of incumbent response ... 6
Incumbent Responses ... 7
METHODOLOGY ... 8
RESULTS ... 15
The first hurdle – survive the disruptive impact ... 15
The second hurdle – overcome forces of inertia ... 18
The third hurdle – respond effectively ... 20
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INTRODUCTION
In the past few decades a lot has changed in the music industry. The days of buying 15 euro plastic discs are gone. People nowadays access a free unlimited collection of music from anywhere they want. It all started with the introduction of the MP3 file in combination with increased access to the internet. This allowed new entrants like Napster to start P2P-file sharing services (Moreau, 2013). These services were of substantially lower quality than the CD offerings, but allowed people to download and share music for free which led to massive losses in the industry (Frohlich & Hess, 2016). It was not until 2003 with the introduction of the iTunes store, that consumers gradually started paying for music again (Moreau, 2013). In this process, complete value networks were destroyed as the new technology rendered the previously important distribution channels of the incumbents’ almost useless (Henderson & Clark, 1990). The digitization caused a large number of incumbents to fail as they ignored the disruptive innovation until it was too late (Moreau, 2013).
Several scholars tried to explain this process of creative destruction (Schumpeter, 1942), the most famous one being Christensen (1997). In his book, “The innovators dilemma”, he explains how incumbents are biased towards the more profitable existing customer needs, and ignore the less profitable emerging customer needs. New entrants can then enter these niches with an inferior product that gradually improves over time, eventually hitting the mainstream market. When this happens, these disruptors offer a substantial price or performance advantage over the incumbents’ product offerings (Christensen, Raynor, & McDonald, 2015), while incumbents overshoot the mainstream demand with their sustaining innovations. This phenomenon explains how new entrants are able to displace established incumbent firms.
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Most of these scholars, however, focused on the success or failure stories of famous companies like IBM, Kodak, or other industry leaders with large R&D departments, and a vast amount of resources (Ansari & Krop, 2012; Eggers, 2014; 2015). Studying mostly large multinational firms reduces the generalizability of the disruptive innovation research. There seems to be a gap in the literature field that compares different types and sizes of incumbents that perished in the face of the same disruption (Christensen, Raynor, & McDonald, 2015). The goal of this study is to generate new theory in order to contribute to the generalizability of the disruptive innovation field. For this reason, the following research question has been formulated:
“How and why do incumbents come to perish in the face of disruptive innovation?”
The answer to this question will have several managerial implications for both managers of multinational firms, and managers of smaller types of firms. They can use the findings of this research to learn more from the mistakes that were made by other incumbents in the face of disruption and thus enabling them to be more aware and prepared for their own possible disruptive threats in the future.
To build further on the disruptive innovation theory, this research studied eight different types of incumbents that failed in the face of disruption, using an organizational level of analysis. Studying a full range of different incumbents that faced the same disruptive innovation has not been researched yet. To get a rich understanding on how and why each incumbent failed, a qualitative method of analysis was used. To answer the research question, different incumbents must be analysed and compared with each other. For this reason several case studied were conducted (Eisenhardt, 1989). The industry that is chosen for this study is the Dutch music industry, as it follows Christensen’s (1997) definition of a disruptive innovation, and resulted in the failure of many different types and sizes of incumbents (Moreau, 2013).
The eight cases consisted of four record labels and four distributors that were selected based on the years in which they operated, and their organizational size. To produce new findings, primary and secondary data was triangulated with the use of semi-structured interviews, a literature review, published news articles, and firm publications (Eisenhardt, 1989). Then a within- and cross-case analysis was conducted, of which the findings were compared to the disruptive innovation literature.
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THEORETICAL BACKGROUND
Disruptive innovation is a powerful phenomenon that was described by Clayton M. Christensen in 1997. In his book ‘The Innovators Dilemma’ he explains how industry giants that seem to do everything right still get displaced by new entrants (Christensen, 1997). This paper attempts to build further on his theory by researching a diverse set of incumbents that failed in the same industry facing the same disruptive innovation. This chapter will now first explain the basic principles of disruptive innovation, then inhibitors of response, and finally response strategies.
Understanding disruption
Christensen (1997) argues that an innovation can either be sustaining, or disruptive. Sustaining innovations incrementally improve a product, by for example adding a fifth blade to a shaver. Disruptive innovations offer a lower quality product, but bring new value propositions to the market. The mainstream customers are not interested in these disruptive innovations until they meet the minimum performance level of the existing offering. Incumbents are biased towards meeting their customers’ existing needs. In their pursuit to achieve higher margins, they ignore the less profitable emerging customer needs. This leaves room for new entrants to experiment and mature in these new markets niches. Christensen (1997) differentiates between low-end disruption and new markets disruption. The first refers to new entrants that offer a lower price solution, while the latter refers to new entrants that introduce new performance dimensions. As time progresses, both the incumbent and the new entrants improve the quality of their product offerings. The incumbents’ sustaining innovations eventually overshoot towards the high-end markets demands, while the new entrant meets the mainstream customer demands. The new entrant is then able to offer the incumbents’ product at a lower price, or with a new performance dimension. The mainstream customers then shift towards the offering of the new entrant, thus leading to the displacement of the incumbent. This process is visualized in figure 1.
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Some scholars argue that the lack of a clear definition of disruption makes it difficult to understand the underlying reasons for the failure of incumbents (Markides, 2006). Danneels (2002) highlights this, as he states that Christensen’s research fails to explain why some incumbents succeed while others fail. Ansari and Krop (2012) continue this notion by stating that Gillette, for example, survived the threat of disposable-razors, and proposed factors that might increase the likelihood of incumbent survival. The fact that incumbents are able to survive disruptive innovations generated even more research. Scholars started to analyse famous stories of market leaders, like IBM, that survived the disruption (Eggers, 2015; Ansari & Krop, 2012). Most scholars attributed incumbent success to industry and/or organizational related characteristics (Ansari & Krop, 2012), others to their response strategies (Henderson & Clark, 1990). Most incumbents, however, were unable to respond due to both internal and external forces. These will be further elaborated on below.
Inhibitors of incumbent response
Many incumbents fail due to a sudden shift in their environment, that can be caused by a change in regulations, an economic crisis, or – in this case – a disruptive technology (Van Witteloostuijn, 1998; Hillman, 2009; Bergek, Berggren, Magnusson, & Hobday, 2013). Not responding to these environmental changes is one of the main causes of organizational failure (Christensen, 1997). Even though incumbents know the dangers of not responding, many still fail to do so. Many scholars researched this phenomenon and mostly contributed the lack of responding to bad management, opportunistic behaviour, inadequate budgetary control systems, and defective cash flow planning (Argenti, 1976; Van Witteloostuijn, 1998). The most prominent inhibitor of response, however, is organizational inertia.
Organizational inertia is a phenomenon made famous by Hannan and Freeman (1977). They define organizational inertia as the force that limits an organization to adapt. It prevents an organization to respond to environmental opportunities, or in this case, environmental threats (Hannan & Freeman, 1977). When organizations get older and larger, they will experience structural inertia and lose their ability to respond quickly. They start to rely more on standardized routines, hierarchical organizational structures, and centralized decision making (Haveman, 1993; Hannan & Freeman, 1977; 1984). Structural inertia can be both generated internally by sunk costs, personnel, and political coalitions, and externally by legal entry barriers (Hannan & Freeman, 1984). Organizational inertia is relative to the speed of which the environment changes, by the time some organizations successfully change, their environment has shifted again (Hannan & Freeman, 1984). Disruptive innovation radically changes the environment (Christensen, 1997), meaning that structural inertia would be lethal for incumbents.
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Barton, 1992). In the case of disruptive threats, blinded perception often contributes to the downfall of an incumbent, as they underestimate the disruptive entrants (Christensen, 1997). In the case of core rigidities, inertia is caused by the core competences that made the incumbent successful in the first place, as they keep doing what they know best (Leonard-Barton, 1992). These incumbents usually have large investments in their existing value network, making them less inclined to change (Kamien & Schwartz, 1982; Henderson & Clark, 1990). The disruptive technology targets the same market as the incumbent, meaning that investing in the technology would lead to cannibalization of its existing product (Kamien & Schwartz, 1982). For this reason, incumbents sometimes deliberately choose to not participate in the new technology. Other times they are willing to exploit the disruptive technology, but lack the absorptive capacity to acquire the knowledge to do so (Cohen & Levinthal, 1990).
Other scholars tried to explain incumbent failure to respond using resource dependency theory (Christensen & Roosenbloom, 1995). This theory states that most incumbents are dependent on other parties in their environment. If this environment starts to shift due to a disruptive technology, the incumbents try to decrease their dependency (Hillman et. al, 2009). Incumbents do this through mergers, joint ventures, assigning a board of directors, executive succession, and political action (Hillman et. al, 2009). For example, incumbents used political action, through lawsuits to make Napster illegal. Other ways for incumbents to respond to the disruptive threat, will be discussed below.
Incumbent Responses
Incumbents can choose different ways to respond. Famous incumbents like Motorola, IBM, and Kodak, responded by creating a smaller internal or external venture that invested in the new technology (Macher & Richman, 2004). In most cases, however, the incumbents first try to contain the threat (D'Aveni, 2002). This usually happens with the use of entry barriers or legal actions, like the previously mentioned Napster case. If incumbents are unable to contain the disruptive threat, they try to shape it in a way so that it fits better with their current business model (D’Aveni, 2002). When the incumbents are unable to shape the disruption to their liking, they usually start to absorb the technology themselves. If the technology, however, develops so quickly that the first three strategies did not work, then the incumbents usually resort to neutralization (D’Aveni, 2002). One way to do this is by giving the benefits that the challenger offers away for free. The last strategy, annulment, can be done by either completely sidestepping the radical innovation or by ‘leapfrogging’ the innovation with another that better suits the incumbent’s strength (D’Aveni, 2002).
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better understanding of this phenomenon, a closer look will be taken at the reasons why an incumbent fails in the first place. Eggers (2015) made a start in analysing firms that were at the brink of failing in an environmental shift. These incumbents had to choose between two technologies and battle for the dominant design. His study, however, only includes famous companies like IBM. Besides Eggers (2015) other scholars have also analysed the success and failure stories of well-known companies, like Kodak and Polaroid. These analysed firms all share similar traits. They are market leaders, have large amounts of resources, extensive R&D spending, and many years of experience. Analysing only the big famous cases reduces the generalizability of the disruptive innovation theory, as there are also many small and medium-sized enterprises that failed to survive disruptive innovations. In order to build further on the disruptive innovation literature, not only famous cases, but also different types and sizes of incumbents that failed in the face of the same disruptive innovation will be analysed. This, in turn, has important managerial applications. Managers can use the results of this report to learn from others mistakes, enabling them to avoid common pitfalls. To generate the findings of this report, multiple incumbents that failed were analysed with an organizational level of analysis. The industry that was chosen for this research is the Dutch music industry. Why this industry was selected, and how this research was conducted will now be explained in the methodology section.
METHODOLOGY
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differences were analysed in a cross case analysis. In order to perform these analyses, the industry setting, and the level of analysis must be chosen (Eisenhardt, 1989). These will be further elaborated in the case description.
Case Description
In order to get an answer to the above mentioned research question, an industry had to be analysed that contained many different types and sizes of incumbents that failed due to the introduction of a disruptive innovation. One industry characterized by a lot of incumbent failure is the music industry. This industry faced a fast decline in revenues after the introduction of the digital format. This so called digitization process follows the latest definition of Christensen, Raynor, and McDonald (2015). It started with the introduction of the MP3 format and the increased mainstream access to the internet in 1997. The MP3 format is a small, easily transferable format that enabled music file sharing on the internet (Moreau, 2013). This combination allowed new entrants like Napster to enter the market in 1999. They utilized peer-to-peer (P2P) file sharing technology to offer a wide range of music that could be illegally downloaded, and easily shared. Much like the definition of Christensen, Raynor, and McDonald (2015), the MP3 format offered a lower quality than the previously offered CD. The disruption of the music industry was a gradual process that had a different business model than the incumbents in the industry.
Incumbents in the industry responded – in line with Cooper and Schendel’s (1976) findings – with lawsuits against Napster. These eventually led to Napster’s demise in 2001. The same year, new entrants like Kazaa, and Aim4Music tried to offer the services of Napster legally in return for a fee. In the same year, Apple entered the music industry with its introduction of the iPod. The rising popularity of MP3 players accelerated the digitization process, as digital music became available for everyone, to be listened everywhere. The quality of digital music offerings however did not improve much until the launch of Apple’s iTunes music store in 2003. The combination of an easily accessible platform that offered a great variety of music at a low prize made consumers willing to pay for music again. There was, however, another threat on the rise with the introduction of music streaming services like Pandora in 2005 and Spotify in 2008 (Moreau, 2013). These services enabled customers to stream music for free via an advertisement based revenue system or pay a monthly fee for an advertisement free premium version. The revenue from streaming services nowadays already surpassed the revenue from digital music sales (Datagraver, 2016). Currently, there are many music streaming services for the customer to choose from: Apple Music, Slacker, Beats Radio and Rhapsody are some of the many services available.
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characterized by a disruptive innovation that is in line with Christensen et al.’s (2015) latest definition, and caused many different types and sizes of incumbents to fail. This makes the music industry well suited for the analysis of this report. After elaborating on the case description, the next step is to select which incumbents are going to be analysed, based on several selection criteria. The way these incumbents were selected will be discussed in the next section.
Case Selection
In this report, failed incumbents in the music industry will be analysed. The music industry however is a worldwide industry that developed differently in every country. To reduce variation in the findings of this report, a single country will be selected (Eisenhardt, 1989). The Netherlands have always been in the top 10 countries with the most market share in the global music industry. The digitization process of the music industry in the Netherlands happened not much later than in the United States: the iTunes Music Store was launched in the United States in 2003 and in the Netherlands in 2004. Both the United States music industry and the Dutch music industry started their rapid decline in revenue after the year 2000, making the Dutch music industry suitable for the analysis of this report.
After selecting the Netherlands for the analysis of this report, the next important step is to define the exact moment of disruption in the Dutch music industry. With so many new entrants like Kazaa, Aim4Music, and eventually Spotify, it is difficult to pinpoint when this exactly happened. This report argues that there were three waves of disruption. The first one was the combination of increased internet access, and the smaller MP3 format, that made it possible for Napster to enter the music market. The second wave of disruption in the Dutch music industry happened when a legal viable business model for the digital format was introduced with the launch of Apple’s iTunes Music Store in 2004. The third wave of disruption in the Dutch music industry was with the introduction of the streaming service Spotify in 2010. Napster, iTunes, and Spotify all follow Christensen et al.’s (2015) definition of a disruptor, as their music quality was lower than the incumbent’s physical product offerings, they had different business models, and they entered an unserved market of digital music that was located in one place. Even though there are three waves of disruption, this report will mainly focus on the first and second wave, as they were responsible for the start of the digitization process in the Dutch music industry. When response time is discussed in this report, it references to the time in between the initial launch of Napster in 1999, and the time it took the incumbent to respond to the disruptive threat.
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in the findings. For this reason, two types of incumbents were chosen: record labels and distributors. These two types of companies share enough similarities to be compared with each other, but are at the same time also different enough to produce new findings. Record labels primary functions are finding, selecting, and guiding new artists. In this process they also take care of the production and promotion. Distributors in turn distribute the record labels or artists products. Similarly to record labels, they also take care of the marketing and promotion of the artist or record label. One difference between record labels and distributors is that record labels have a high involvement with the artist and his content, while distributors do not have influence on the content itself. Another difference is that distributors are mostly bigger in size to make use of scale advantages. The business models of record labels and distributors are however similar, as they both mostly profit from the sales of CDs. The digitization process in the Dutch music industry attacked their business models by drastically reducing the CD sales (Datagraver, 2016). This led to the bankruptcy of many record labels, and distributors.
The following selection criteria were used in the selection of the cases. First, the firm entered the Dutch music industry before the introduction of Napster in 1999. Second, the firm survived the disruption of Napster for at least two years before exiting the Dutch music industry. In the theoretical section it became clear that majors had already been extensively researched in different papers, so this paper focussed only on the independent incumbents. To generate new findings, both small, and large incumbents were analysed. The Dutch government classifies companies as either micro, small, medium-sized, or large, based on their average number of employees, and turnover.
Of the initial list of 100 incumbents, 30 incumbents matched the two criteria, and were contacted for a semi-structured in-depth interview. Due to resource and time restrictions, a total of four record labels, and four distributors will be analysed. The companies of the eight cases are summarized in the appendix. Table 1 shows the general information of each case.
Incumbents Focus Start Exit FTE Size Interview
Rhino Records Rock 1998 2011 3 Micro Marketing manager
Bull Records EDM 1998 2001 9 Micro Company director
Python Records World Music 1998 2010 35 Small Vice-president Europe Coyote Records Rock 1980 2012 300 Large Vice-president Europe Mammoth Distribution EDM 1995 2002 20 Small CEO
Hawk Distribution General 2008 2010 140 Medium Commercial director Tiger Distribution Pop & Classic 2009 2014 60 Medium Sales manager Fox Distribution Pop & Classic 2000 2010 200 Large* Controller *Tiger Distribution, classified as large, with a turnover of €60 million
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All eight cases match the selection criteria, with the exception of two: Tiger, and Hawk Distribution. Tiger Distribution entered the market five years after the introduction of the iTunes Music Store, and normally would not be classified as an incumbent. This firm however is a buyout of another case in this analysis: Fox Distribution. In the year 2009, Fox Distribution wanted to get rid of its popular music department, and sold it to one of its managers. Tiger Distribution is thus a department of an existing incumbent that continued under a new owner, and name. The other case, Hawk Distribution entered the Dutch music industry in 2008 after acquiring the retail franchise Music Store. The company used the same traditional business model of other incumbents, by distributing physical music products to stores. They had an initial plan to combine physical sales with an online platform, but failed to launch it. Due to similarities and the use of the same business model as older incumbents, Hawk Distribution can be included in the analysis of this paper. After selecting the cases it is possible to study them by collecting different data sources, and using structured analysis methods. These will be further elaborated below.
Data Sources
13 Data Collection
Interviews are a crucial source of information for theory building, as their retrospective insights allow for new theoretical findings (Gioia et. al, 2013). They also allow for different types of biases. Researcher bias was reduced by conducting the interviews with two researchers (Eisenhardt, 1989). A second researcher allowed for complementary insights, different perspectives, and an increased richness of the data and thus resulted in a higher probability of new insights (Eisenhardt, 1989). To further reduce researcher bias, an interview protocol was created prior to the interviews, and added to the appendix of this report. The interview protocol was semi-structured, as it contained general questions regarding the background of the interviewee, the company, and the market it operated in, and specific case related question about the digitization process, and the reasons for bankruptcy. The previously gathered background information was then verified during the interview, and used to go into deeper detail on some of the company’s decisions, effectively reducing the retrospective bias. The interviews were conducted via Skype and took approximately 60 minutes each. At the start of the interview the goal of the research was summarized, and permission was asked to record the interview. During the interviews field notes were taken regarding informal observations, and hunches about underlying relations. These field notes were crucial for achieving overlap between the data collection and data analysis of this report (Eisenhardt, 1989). After discussing general background information, the digitization process, their response strategies, and reasons for bankruptcy, the interviewee was asked how he would have done it differently in hindsight. After the interview was concluded, a transcript was made and sent to the interviewee for feedback and approval, increasing the reliability of this research (van Aken et. al, 2012). Once all the data was collected, it was possible to conduct the within- and cross-case analysis. How these were conducted will be further elaborated on below.
Data Analysis
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to reduce information-processing biases (Eisenhardt, 1989). The selected dimensions were: organizational type, organizational size, year of entrance, year of exit, and restarts. First, every record label was compared with each other, two cases at a time to look at the subtle similarities and difference (Eisenhardt, 1989). Then the same was done for the distributors, before comparing the record labels and distributors with each other in groups of four to find overall similarities and differences (Eisenhardt, 1989). The same process was then repeated for the other dimensions. The outcome of the 1st, 2nd, and 3rd order concepts of the cross-case analysis is shown in figure 2 (Gioia, Corley, & Hamilton, 2013). The cross-case analysis resulted in three aggregate dimensions why incumbents failed in the face of disruption. These aggregate dimensions are financial losses, inhibitors to disruptive responses, and inadequate disruptive responses. To enhance generalizability, internal validity, and theoretical level of theory building from case study, the findings will be tied to a broad range of existing literature (Eisenhardt, 1989). The research section below will go deeper into these aggregate dimensions.
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RESULTS
This section will reveal the results that emerged from the eight studied cases. First, an overview will be provided of the main reasons how incumbent perished in the face of disruption. Second, the results of why the studied incumbents failed to overcome these main reasons will be revealed.
The three hurdles
In the search of how and why the studied incumbents perished in the face of disruptive innovation, three hurdles were identified. Every case failed to overcome one of these three hurdles and had to exit the music industry. First, incumbents need to survive the initial impact that the disruptive innovation has on their financial resources. Second, incumbents must overcome their internal forces of inertia in time, to make the decision to alter course. Third, once incumbents selected a new course of action, they need the right resources to ensure its effectiveness. This section will now discuss every hurdle and their implications in more detail.
Figure 3 Incumbents exit paths
*From left to right; Bull Records, Mammoth Distribution, Hawk Distribution, Fox Distribution, Tiger Distribution, Rhino Records, Coyote Records, Python Records.
The first hurdle – survive the disruptive impact
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Around the year 2003, the opportunities of pre-empting or neutralizing the threat of disruption were long gone for the Dutch music industry, as the disruptive technology was making its way to the mainstream market. The following years, the digitization of the Dutch music industry would start to radically reduce the sales of physical music products, as yearly industry revenues dropped by up to 15% (Datagraver, 2016). The digitization of the Dutch Music industry is also clearly shown in the studied cases. Within four years the financial resources of Bull Records, Mammoth-, and Hawk Distribution dried up, leaving them no other option than to leave the market. How was it that these three failed so quickly where most others managed to survive for another decade? Upon further analysis, these three cases showed several similarities.
First, both Bull Records and Mammoth Distribution were smaller incumbents that focussed on popular dance music, a genre that would become one of the most pirated in the industry. Second, both Bull Records and Mammoth Distribution established long-term inflexible contracts. Third, Hawk Distribution and Mammoth Distribution both faced an unexpected external event other than the disruption that drastically impacted their financial resources. The following quotes of the interviews with the managers of the three incumbents shed more light on these three similarities.
Bull Rec.
“Due to the intense competition over media time, TV contracts were very expensive and inflexible. We couldn’t terminate the TV contract without paying 75% of its cost. Our revenue dropped while our costs stayed the same, eventually leading to our bankruptcy”
Mammoth Distr.
“In order to differentiate from the competition, we signed contracts with our clients to always pay upfront. This wasn’t a problem until two airplanes struck the World Trade Centre. The resulting financial crises led to our American customers not paying us anymore, while we already had to pay our clients in advance.”
Hawk Distr. “Hawk bought the Music Store with a large loan from an investor. Not many people knew
of this. Once the investor suddenly declared bankruptcy, Hawk had to repay its dept.”
17 Python Rec.
“In Europe we already had 2500 stores that played our music in the background, so that customers could impulsively buy the CD at the counter. When we release a new CD, we want to send all those stores a promotional CD. Buma/Stemra however only allows for a limited amount of promotion CD’s. We said that we couldn’t operate our business without these promotional CD’s, but they thought we were bluffing, and would give in. But we weren’t bluffing and declared bankruptcy, after which we made a restart with the use of UK’s less strict regulations.”
Rhino Rec.
Rhino Records was part of the owner’s construction company. We operated in their office and even could make use of their secretary. Once the parent company declared bankruptcy due the housing market crises, we discovered that we couldn’t operate without its resources and also had to declare bankruptcy.
Resource dependencies also partially explain why the other five incumbents were able to overcome the first hurdle. The case studies show that an incumbent’s strategic orientation plays a vital role in this.
Coyote Rec. “Our CEO knew that the profits of the record companies weren’t located in just one market,
but rather in the big markets of Europe and America.”
Python Rec.
“We owed a big part of our success to the use of alternative distribution channels around the world. Think of bookstores, coffee shops, even cruise ships.”
“Python Records sells World music that is timeless. Some our CD’s are 15 years old, and still sound good and fresh.”. “Our music is mostly bought by an older customer group”
Rhino Rec.
“You could compare us with an indie label that focussed on making local rock bands a success. Later we started to focus on small art theatre, here we could still successfully sell CD’s after a band performance.”
Fox Distr.
“When you compare the sound quality of an mp3 to a CD recording, there is no way a classic music fan would choose digital.”
“Besides music, we also had a fast growing videogame and book department.”
Tiger Distr.
“The music market has shrunk substantially, but the drop in sales differed per market.” “Our classic music department focussed on an older customer of 55+ years old, who don’t bother with new technologies.”
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These strategic orientations explain the rapid drop in revenue of Bull Records that only operated in the Dutch music industry, and did not have a niche. They however do not explain the short survival of Mammoth Distribution, that also operated in the international markets of the US and Japan. It seems that having only one strategic orientation is not enough to survive the initial impact of the disruption. This finding is underlined by the fact that the incumbents that managed to overcome the first hurdle all used a combination of multiple strategic orientations. In short, even though each strategic orientation on its own is renown in the literature as a means of survival, this study finds that they only prove to be effective once they are combined. These findings lead to the formulation of the first proposition.
Proposition 1: Not the standalone value, but rather the combination of multiple strategic orientations,
like operating internationally, having a niche market focus, and operating in different industries, effectively dampens the impact that the disruptive innovation has on the incumbents’ finances.
Using a combination of these strategic orientations helps incumbents survive the initial impact of the disruptive response, but only delays the inevitable drop in revenue of the current technology. Incumbents still need to take action before the disruption catches up to them. In line with Christensen (1997) findings, many cases knew the threat of the disruptive innovation, but still failed to timely respond to it. The case analysis of this phenomenon identified a second hurdle that many of the studied incumbents, like Fox Distribution and Python Records, failed to overcome, namely the forces of inertia.
The second hurdle – overcome forces of inertia
The next section will discuss why some incumbents, like Python Records and Fox Distribution, took up to a decade to participate in the disruptive technology, where other cases, like Coyote Records and Mammoth Distribution, already participated in it before the introduction of Napster. Humans, by nature, are bad processors of information, and notoriously known for their resistance to change, a deadly combination in situations where a fast response can make the difference between organizational survival and organizational death. When a radical shift in the environment takes place, an incumbent generally has two options to choose from: either respond or do not.
19 Fox Distr.
“We all had employees that experienced the glory days of the music industry, thinking that the digitization wouldn’t be so fast, and that there was plenty of time to react. We thought Let’s just focus on what we are good at, and always earned money with’. The fact that we were so unprepared for the digitization caused huge delays.”
Tiger Distr.
“The CEO had the feeling that the market would recover. He thought the failure of other distributors would present him with new distribution opportunities.”
“Our gadget department was a big success. I have the feeling we could have survived, If we just had one more year, then we could have steadily shrunk the organization in size. But the drop in revenues were just so fast, that we had cash-flow problems on a monthly basis.”
Python Rec.
“We didn’t want to digitize, because we wanted to support the alternative retail stores that have always been loyal to us.”
“I think we should have started to diversify earlier, and in more different ways. Digitization is not the future for record labels, diversifying is.”
These remarks show that Fox- and Tiger Distribution’s late responses can mostly be attributed to the internal inertia they experienced on their managerial-, cultural-, and structural level of their organization, while Python Records’ main reason for late response came forth out of the unwillingness to cannibalize its loyal retailers. To underline the impact of internal inertia, the reasons for Coyote Records’ and Mammoth Distribution’s early participation in the new technology were analysed. From the interviews it seems that their CEO’s – unlike the ones mentioned above – were aware of the urgency of the disruptive technology.
Coyote Rec.
“My boss knew the importance of the digitization, and acted very early on. We were among the first to register ISRC in the industry. My boss knew it was vital to register his music for online sales”.
Mammoth Distr.
“When I founded the company, we already made use of the internet to promote our sales.
Instead of calling them, we allowed our customers to listen to our soundbites online
It shows that the CEOs of these incumbents were the driving force for their early response. More remarkably, in contrast to most organizational literature (Haveman, 1993), the largest and oldest incumbent of the case studies was among the first to participate in the new technology, while smaller incumbents like Coyote Records were late in their participation of the disruptive technology. From the case studies it seems that it is not the organizational size or age, but rather the lack of urgency of the CEO to participate in the disruption that severely delays the incumbent’s decision to respond.
20 The third hurdle – respond effectively
This section will discuss the different types of responses that the studied incumbents used in the face of disruption, and explain why these responses failed. The case study identified that the incumbents each used one or more of the following five responses to the disruption: (1) participate in the disruptive technology, (2) invest in existing technology, (3) diversify within the industry, (4) diversify across the industry, and (5) reorganize. Figure 4 shows which strategy the incumbents used. Each of these responses will now be discussed.
Figure 4: Response strategies
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As in line with the disruptive literature, incumbents like Mammoth Distribution that participated early in the disruptive technology had trouble with the underdeveloped online infrastructure and business model of the new technology. Hawk Distribution, just like Mammoth Distribution, wanted to link physical and digital sales together by buying one of the biggest music store chains in the Netherlands. The large investment needed for this backfired, as their financer suddenly declared bankruptcy. Coyote Records’ platform failed because their Rock and Metal customers were not interested in ringtones, and they needed expensive promotion to reach other customers. Rhino Records faced the same problems as Coyote Records, as its platform also was not able to attract a large enough volume of customers. It was not until the launch of the iTunes music store (Moreau, 2013), that incumbents were able to bring their songs to the masses. This however still proved to be difficult for the cases of Python Records and Fox Distribution. Both cases were inhibited in their ability to participate in the new technology due to previously established license contracts. The managers mentioned the following:
Fox Distr.
“Once we wanted to digitize, we discovered that many of our license contracts didn’t include digital rights. These digital rights were mainly owned by the majors, who wanted to exploit them themselves.”
Python Rec.
“Our albums consisted of a variety of artists from all over the world, and we had a license contract with every one of them. This meant that if we wanted to put an album online, we had to renegotiate the contract of every artist on it. For that reason we couldn’t digitize our older catalogue. Only our latest albums were published online.”
Coyote Rec.
“We launched a mobile ringtones platform, because those were popular at the time. But I have seen the statistics, and it wasn’t successful. Sometimes customers automatically go to your platform, other times you have to invest a lot of money to get people them. If you then don’t earn money with it, you might as well stop doing it.”
Mammoth Distr.
“We prepared an online download portal for the next step; a combination of physical product sales and downloads. That system was ready to launch before YouTube, and Beatport. But we had troubles with the DRM system of Windows. You had to buy special software, and pay a ridiculous amount of money to protect your songs. Another problem was that micro
transactions weren’t a viable option, as you had to pay 50% over your 1 dollar sale. Now you only pay a small percentage over them. Then Beatport came in and offered music without the protections. By the time we wanted to do the same, our financial resources ran dry”
Rhino Rec. “Our songs could be downloaded online for a price. We did this via a 3
rd party platform, but we only sold a handful of songs.”
Hawk Distr.
22
The previously established license contracts of Python Records and Fox Distribution made it impossible for them to digitally exploit the full extent of their music. This resulted in a slower and less effective participation in the disruptive technology, leading to the formulation of the next proposition.
Proposition 2: Legal constellations that are established prior to the disruptive innovation largely
constrain an incumbent’s ability to participate in the disruptive technology.
In an attempt to overcome these limitations, Python Records started including digital licenses in their new albums, while Fox Distribution paid an expensive intermediate to do the digital exploitation for them. Both incumbents were eventually able to release their content on iTunes. They however still had trouble to survive, as the iTunes store carved into their margins with a fee of 30 to 40% per sale.
Besides participating in disruptive technologies, some incumbents, like Rhino Records and Hawk Distribution, invested in existing and older technologies. Rhino Records, for example, reintroduced vinyl in an attempt to sell nostalgia. This attempt however failed, as vinyl was not popular at the time, and had yet to make its popular reintroduction in the industry. Hawk Distribution, in turn, also invested in the existing technology in an attempt to respond to the disruptive threat. They bought a franchise that owned over 150 brick and mortar music stores, with the idea to combine physical and digital sales. The bankruptcy of their financer however, resulted into the failure of this plan. From these two examples it seems that reinvesting in older technologies is not necessarily effective as a response strategy.
Other cases did not invest in older technologies, but choose to diversify within and across industries. In this study, record labels were more likely to diversify within industries, while distributors were more likely to diversify across industries. This makes sense, as record labels like Python Records can easily introduce their music to different customer groups, by for example releasing CDs for children. Distributors on the other hand can more easily enter other industries with different products by leveraging their distribution infrastructure and capabilities. Tiger Distribution illustrated this by starting a joint venture with a gadget company. Their gadget department experienced a fast growth and became a big success. Furthermore, this study shows that cases that diversified were able to survive the disruption for longer periods of time than cases that did not. It however did not guarantee success, as even these cases failed to survive in the face of disruption. In the case of Tiger Distribution, the CEO’s decision to hold onto their core business was the main reason for their downfall.
Tiger Distr.
23
This quote highlights a remarkable finding of this report. All incumbents in this study kept their shrinking core business, while pursuing other strategies. This strategy is renowned for the stress it puts on the resources of both activities. The success of Python Records restart however, shows incumbents do not have to abandon their core business to be able to survive the disruptive innovation, highlighting the next finding of the case studies: the urgency of downsizing. The studied cases show that incumbents either focus heavily on finding new sources of revenue like the ones mentioned above, or focus heavily on downsizing. The first was the case for most record labels; the latter was the case for most distributors. Even though the literature addresses the importance of either one of these, this study finds they are not effective until they are combined in a timely matter. These findings lead to the following proposition.
Proposition 3: It is not enough for an incumbent facing a disruptive innovation to survive by either
finding new streams of revenues or effectively downsizing their organization. It is rather a timely combination of the two that increases its likelihood of survival.
Python Records’ successful restart and survival in the music industry summarizes the findings of this report. First, the organization drastically reduced its size from 35 to 9 employees, effectively reducing costs. Second, the organization operates in a niche, characterized by low competition. Third, the organization operates worldwide, increasing their range of potential customers. Fourth, the organization both utilizes its old value network by selling the old technology to its loyal customers, while at the same time offering its products to new customers using the disruptive technology. Fifth, the organization diversifies both within and across industries by targeting different customer groups, and leveraging their brand to sell products like travel journals and colour books. The three formulated propositions explain the failure of most of the studied incumbents, and describe the successful restart of Python Records. The implications of these propositions on the literature field will now be discussed below.
DISCUSSION
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To address this gap, this study researched two different types of failed incumbents of four different sizes. It then formulated the research question: ‘how and why do incumbent firms come to perish in the face of disruption?’ After which three hurdles were identified that each of the incumbents failed to overcome. From the results a total of three propositions emerged.
First, some incumbent firms like Bull Records survived the disruption of Napster in 1999 for only four years, while others, like Python Records were able to survive for over ten years. This study found that the incumbent’s strategic orientation played a vital role in this. Incumbents like Python Records, Tiger Distribution, and Fox Distribution all used a combination of operating internationally, having a niche market focus, and operating in different industries. They each effectively survived the disruption for up to twelve years. D’Aveni (1989) strengthens this notion by stating that only the strategically well-positioned firms are able to survive a decline in demand. This study builds further on his research by identifying three strategic orientations, and underlying the importance of combining them.
Haveman (1993) states that organizational size affects the degree to which organizations diversify. In his research he states that large organizations are better able to expand due to market power and slack resources, but are at the same time more inert and bureaucratic. He also states that medium sized organizations strike the right balance between having sufficient resources, and being flexible. The findings of this study contradict this as both large and small incumbents faced substantial amounts of inertia. Furthermore, the medium sized company Tiger Distribution faced managerial inertia, as its CEO did not want to drop its core business in pursuit to his gadget company. Overall, this study presents no relation between organizational size and inertia. Coyote Records highlights this, as the oldest and largest studied incumbent with over 300 FTEs was even able to participate in the disruptive technology before the introduction of Napster. Van Witteloostuijn (1998) sheds more light on this phenomenon. He states that failure rates of firms decrease with age and size. With 32 years, Coyote Records was also the oldest of the studied cases. The study found that Coyote Records was able to respond quickly and survive for many years because of its competent, forward thinking CEO. This is in line with the existing literature that discusses how effective leadership can be used to overcome organizational inertia. Van Witteloostuijn (1998) argues that the ability of the management to respond is crucial for incumbents to have a turnaround success.
25
Remarkably, all eight cases did not abandon their core business while pursuing other options. Tiger Distribution even attributed their downfall directly to the fact that they did not abandon their core business in time. Incumbents keeping their core business while trying to respond to the threat might be less likely to survive. Cooper and Schendel (1976) already found that incumbents that pursued a duel strategy were usually unsuccessful. It especially hindered the firm’s ability to build a strong competitive position in the disruptive technology.
The third and final proposition refers to downsizing, and finding new revenue streams. In the studied cases only the larger firms downsized when they faced a decline in revenue. Downsizing alone, however, was not enough for them to survive. Leading to the third proposition: incumbent survival is neither determined by finding new sources of revenue stream, nor by downsizing, but rather by the timely combination of both. This notion is supported by D’Aveni (1989), who states that downsizing may buy time, but does not necessarily lead to a turnaround success. Downsizing even may become part of the firm’s problem, as it deludes the incumbent temporal well-being. This study builds further on his research by highlighting that downsizing can be effective if it is done in combination with finding new sources of income
CONCLUSION
After discussing the findings of this report, this section will answer the research question; “How and why do incumbents come to perish in the face of disruptive innovation?” In short, incumbents failed to survive the disruption due to the following factors. First, incumbents failed to survive the initial impact of the disruption due to a lack of multiple strategic orientations, like operating in international markets, having a niche market focus, and operating in different industries. This caused the incumbents’ revenues to drastically decline in a short period of time, with nothing to compensate for it. Second, incumbents that did survive the initial impact were eventually caught up by the disruption by responding too late. The late response was mainly caused by internal forces of inertia, and previously established legal constellations. Third, the incumbents that did respond to the disruptive innovation still failed. Pursuing different streams of revenues only proves to be effective, if it is done in combination with downsizing. Python Records made a successful restart after it sufficed all the above mentioned conditions.
Managerial Implications
26
preferably also operating in different industries. Combining these different strategic orientations effectively dampens the financial impact the disruption has on the firm. Second, organizational inertia should be reduced by the incumbent as much as possible. This study especially highlights the manager to be a forward-looking organizational leader. Third, once the disruptive threat drastically reduces the revenues of their company, managers should downsize in combination with finding new sources of income in order to survive.
Limitations
This research has several limitations. First, this research acknowledges that it was limited to the study of eight cases. Second, this study deliberately chose only two different types of incumbents, namely distributors and record labels, in order to better compare their differences and similarities. This study tried to add more diversity to these two types of incumbents by selecting them based on different sizes. Fourth, the case interviews were conducted with a single member of each case. To increase their validity, a second researcher was added to the case interviews.
Future research
In order to increase the generalizability of these findings, future research could study more different types of incumbents of different sizes in different types of industries. Furthermore, future research could use quantitative methods to test the three propositions produced by this report. This report identified that the combination of different orientation factors mediate the impact that the disruptive innovation has on the finances of the incumbent firm. There is, however, a lack in understanding how much each strategic orientation impacts the incumbent on its own, and which combinations are the most effective for an incumbent’s disruptive survival. Future research could find the most effective combinations.
Acknowledgements
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APPENDIX
Interview Script
Hello, my name is Sebastiaan Phijffer and I want to thank you for the participation in my research. I want to shortly introduce myself and my research, and then would like to ask you some general and specific questions about your company. This interview will be recorded in order to produce a transcript that will be sent to you. Any suggested adjustments will then be made. In the email I sent you I already discussed some of the main goals of my research, and why your company was selected for my research. This master research paper’s goal is to discover how and why incumbents in the Dutch music industry failed. To come towards a closer understanding to the phenomenon of disruptive innovation. I would like to start the interview now with some general questions.
General information
1. Could you tell me something about your company?
- How was it founded? What was their business model? Organizational size? Market focus?
2. What were your main responsibilities within the company?
3. How would you describe the market your company operated in?
4. What was your customer focus?
5. How fierce was the competition?
6. How did you differentiate yourself from the competition? Digitization
7. How did you experience the digitization of the music industry?
8. When did you first notice the impact of the digitization of the industry?
9. What kind of impact did it have on the company?
10. How did the company react to the digitization? (Strategies)
11. What were the main challenges to respond to the digitization?
12. Why did the organization declare bankruptcy?
13. Was there are restart, or attempt to restart? Retrospect
14. In hindsight, what would you have done differently?
15. Why do you think that other incumbents were able to survive the digitization?
16. What kind of advice would you give incumbents facing a disruptive innovation?
32 Case summaries:
Coyote Records
Founded in 1980, Coyote Records was world market leader in the Rock and Metal scene. They represented famous American artists and operated around the world. The record label searched for an investor in order to release two big albums. It made a deal with Warner in 2001 to be gradually acquired into its repertoire. This eventually happened in 2010. Warner then started to cut cost and downsized almost all activities of Coyote Records. This led Coyote Records to close their office in the Netherlands.
Bull Records
Bull Records was a small record label founded in 1998 that focussed on the Dutch dance music industry. It created dance compilations that it primarily marketed via television channels. The focus on dance music meant that the company faced a steep decline after the introduction of Napster in 1999. Dance music was particularly popular among students; the same group that participated in illegal downloading the most. In just four years after the introduction of Napster, Bull Records got into bad weather and declared bankruptcy.
Python Records
Founded in 1998, Python Records first used to be a clothing store, but grew out to be the market leader on World Music. The company focussed on selling CDs to alternative distribution channels like book stores and cruise ships. The company had a strong brand through the use of a consistent art style. It used this art style to differentiate itself by selling multiple products like travel journals, and colour books. The company eventually got into bad weather as the digitization of the industry reduced its income. This in combination with a lost suitcase again Buma/Stemra, resulted into the company declaring bankruptcy in 2010. It then successfully restarted the same year.
Rhino Records
The company was founded in 1998 as a small rock label that focussed on promoting local bands. It had a total of three employees, of which one was the owner of a big construction company. The others were band members of popular local bands and together they represented other local bands. The company got into trouble in 2011, as the construction company of the founder declared bankruptcy due to the housing crises. Rhino Records was dependent on the founder’s resources and could not continue to operate afterwards. Thus they had to declare bankruptcy themselves.
Mammoth Distribution
33
in the United States and Japan, and was the number one distributor of dance music in the Netherlands. The company declared bankruptcy in 2001 as both the digitization and the events of 9/11 drastically reduced its sales.
Hawk Distribution
The company bought the Music Store retail chain franchise in 2008 with the idea to combine both physical and digital product sales. It started to build an online music platform comparable to Spotify. This platform allowed customers to download the songs that they purchased in their stores. However, two weeks before going live, the financer of Hawk Distribution declared bankruptcy. The bankruptcy of Hawk Distribution followed in 2010, as they had to repay their dept.
Fox Distribution
The company was founded in 2000 and specialized in the marketing, promotion, and distribution of digital and physical music products. It first focused on Pop and Classic but eventually only continued with Classical music. The company was known for local famous artists and started many divisions like book-, movie-, and magazine publishing. It operated worldwide and opened holdings in Belgium and Turkey. It finally declared bankruptcy in 2010 because of their loss in revenues caused by the digitization of the music industry.
Tiger Distribution
