Many large companies find themselves launching new businesses at unprecedented rates in an effort to maintain growth profiles, margins and leadership status. When a company pursues new markets, that can include a variety of corporate initiatives which are distinct from each other. At the highest level in terms of potential value creation is the process of vying for a new category. I call this category-creation or entry. Category-creation is different than finding a new market for an existing line of business.

In the latter case, an existing product or service is re-oriented from a positioning, capability and/or distribution standpoint beyond existing customer focus into distinct and additive customer groups. This can be a complex activity for an established business because success often leads to inertia. In other words, it’s hard but necessary to unlearn certain aspects of an existing success formula in order to make the business mix work for new sets of buyers. Expansion of existing products lines into new customer groups holds a lower risk profile than the pursuit of a new category because some aspects of these new markets leverage existing capability. But product line expansion to new segments also carries lower magnitude of order growth potential. Only truly new categories move the needle in breakout ways.

These two growth strategies are equally important — one should not exist without the other. But it’s far more likely that a company is proficient at market expansion than market creation and development. That’s why I’m going to share some thoughts on the category-creation process.

Just to clarify any confusion, here’s a quick test to determine whether a market opportunity falls into one bucket versus the other:

Let’s consider a recent example. Have you ever seen a Zip Car? In case you’re not familiar, it’s basically a “car sharing service” which allows someone to use a car over days or day-parts “without the hassle or owning or renting.”

You might be thinking — “hey, sounds like renting but at a more granular level.” That’s true in some respects but we’ll demonstrate why its truly a new category using our test. First, does it bring new customer groups into the fold? Absolutely. Local residents who do not have the need or cannot justify the costs of ownership. Prior to the category, these folks were either not consuming or consuming in structured ways (”hey friend, can I borrow your wheels for a day?”).

Traditional car rental is not friendly to this kind of consumer. Not enough locations in urban areas. Too expensive. Defined drop-off points and timings. Minimal rental period of a 24-hour period. All those factors add friction to consumption. It’s understood that these folks may rent cars in their travels — we’re not saying the urban dweller will use Zip Car when vacationing for a week in Florida. This is a local play.

When we look at the operational side of things, we see minimal common denominator between traditional rentals and Zip Car. With Zip Car, you walk a block or two to get the vehicle, gas/insurance is included, to start the rental you simply swipe a card on the car door, you can rent for part of a day, the car you reserve is the one you get. The list goes on. Decomposing this from an operational perspective reveals little capability leverage for a traditional rental car company — no real estate investment, web self-service, customization, more field personnel. Yikes, sounds like a different business altogether.

Zip Car is new category because it changes the way business is done in car rentals, embracing new customers and changing the operational formula. This is different than logical progressions of industry change and innovation.

An example of a non-disruptive change is the introduction of premium brands at car rentals. This is where the customer can rent luxury cars like Jaguar or BMW instead of Buick or Chevy.

The modes of consumption in this case are static compared to traditional car rental…meaning how, why and where you rent does not vary. What you rent is altered slightly. Customers have more choice.

Test for New Core => Have the modes of consumption been disrupted?

Disruptive modes of consumption are the central aspect of new categories. Why? Because they change the required operational requirements. Like I said, it’s hard to teach an old dog new tricks, especially if the old dog is successful with one already. As you might see, premium cars were non-disruptive to consumption because there’s nothing new to the consumption mix (where, why, how) in using the service. Same rental process and experience for the consumer. Compare this to the divergent operational requirements that support the mode of consumption in “car sharing.” It’s a different kind of customer behavior and experience altogether.

Accordingly, premium car rentals are an example of growth via product portfolio expansion. It’s not category creation but it does embrace a new customer segment by introducing a more tailored product.

All of this is not meant to imply that changing how customer behavior is beneficial in and of itself. Actually, it’s more likely to be counter-productive to value creation. If you look more closely at the Zip Car example, you’ll notice that the service is putting commercial structure around a way of consumption that is already taking place. People are borrowing cars from friends or renting cars in the traditional manner for local purposes in the absence of car sharing. Consumption is already taking place but there’s no industrial framework behind it. It’s important to recognize, therefore, that Zip Car is not predicated on changes to customer behavior. It’s simply compliant with the way consumption is already unfolding or the way customers would find it most convenient without any persuasion required.

So are there categories which can be built on the presumption of behavioral change? Yes, but not easily. And not profitably in any systematic way. These category-level opportunities are truly exception cases.

You can tell that I believe not all category creation opportunities are alike.

There are three variants in my mind. I’ll refer these category creation situations in the following ways:

Let’s talk about Secular category creation and how it relates to behavioral change. First, it’s secular because it’s independent of the business strategy of one or more industry participants. Instead, it’s driven or initiated by non-commercial forces, including society (shifting attitudes) and government (regulation, policy). An example would the Green Living movement that has gone mainstream over the last few years. Green Living is an example of cultural revolution, which is a tidal wave or perfect storm of market factors that align to alter user or customer behavior with unique momentum. In other words, one or two companies alone, no matter what their size, cannot induce this kind of behavioral change. An entire chain of stakeholder– public/private, media/industry, grassroots/top-down - is an entirely different matter. Why? Because the informational investment is huge and requires broad cooperation.

The domain of behavioral change is a very dangeours one for businesses. Behavioral change is the largest barrier to adoption and the difference between a market in theory and a market in practice. I’m sure data would prove these initiatives generate the lowest returns to a business on invested capital and effort on the aggregate. Industry alone cannot profitably bear the sigifnicat cost of eduction when it comes to informing markets about altering core elements of consumption (why to buy it, how to use it).

Green Living is one major exception to this harsh but realistic view of categories dependent on behaviorial change — and we’re experiencing it right now. But keep in mind, Green was a long time in the making. Environmental non-profits have been around for a long time soliciting petitions. Have many people read Al Gore’s first book about environmental urgency (Earth in the Balance) circa 1992? Point being — this was pretty fringe for a while.

Just to contrast Securlar Category Creation with Category Re-Alignment. In the case of Zip Car, you have a form of consumption that exists and does not require much customer education or explanation because people already make use of it to serve their needs. Everyone rents car, right? Car rental is a self-explanatory proposition. But what Zip Car adds is a new mode of car rental focused on a new class of consumers — local residents who periodically require their own wheels. Shifting the customer experience and operational approach to better address the needs of this under-served market is the basis of the “realignment” in this case.

Category Realignment is the most common and best risk-adjusted way to move the growth needle. Here are some recent examples (in historical order) of industrial realignment:

Each of these examples spawned $bn+ revenue opportunities for disruptive companies (almost all of them new businesses with Nintendo being a major exception).

Our third bucket is the type of opportunity with the biggest impact potential. This is where the needle can really move off the charts. It’s category Inception. Starting with definitions, category Inception is about a new product/service which has no precedent in terms of consumption which takes off based on grassroots dynamics. In other words, it’s a new type of behavior which is being adopted bottoms-up by the market instead of top-down (as in the case of Secular categories). There is no massive investment by industry and societal forces to make category Inception happen but it takes off nonetheless. Inception categories can be just as big as Green Living but seem to come out of nowhere and the gains sometime accrue to a few companies.

There is also contrast between Inception and Realignment categories. In the case of category Realignment, many opportunities are based on the fact that consumption is happening but in unstructured ways. In the Residence-Style Hotel example, this behavior might include things that travelers to do make a traditional hotel stay more homey. The consumption is unstructured because the burden is on the customer and not part of the consumed offering. In the case of Premium Pet Food, it’s likely that owners were using non-pets foods that met desired quality levels before premium pet foods were available.

By contrast, we cannot look to prior behavior when evaluating a category Inception opportunity. That certainly makes category Inception very risky. Many category Inception opportunities occur in the technology sector because human interaction with technology can lead to new types of behavior. Moreover, in today’s web culture, there’s a frictionless channel to put out something new to see if it gets adoption and grows virally. Declining development costs also play in the favor of this. Some examples of category Inception include:

- Social Networking (Facebook, MySpace)
- Virtual Worlds (Second Life)
- Search Engines (Yahoo, Alta Vista, Lycos, Excite, Google)
- Email (Hotmail)
- Online Service (AOL, Prodigy, Compuserve)

As you can see, these types of opportunities are pretty rare. This implicates the approach to managing innovation of this variety. Specifically, it’s important to be very experimental and incremental as a means of risk management. There needs to be a tighter focus on market validation through rapid iterations of product concepts and customer experiences. And it’s important to tie commitment, investment and expectations to the degree of market acceptance.

Large companies are not typically well-suited to pursue these opportunities because they seek more certainty out-of-the-gate about the chances for any given new market initiatives to pan out. They may not be willing to settle for a success rate of 2 out of 10 new businesses, though that might be a fantastic outcome if the right bets turn out to be big and the wrong bets are detected early. Category Inception is much more of a portfolio-play that venture firms are set-up to support. Some large companies, such as Cisco, are attempting to find the middle ground and seeing success with their approaches.

On a different note, while new categories are most likely to driven lead by new companies, incumbents and existing businesses can respond. In a recent example, Blockbuster has done that against Netflix, the category innovator.

Here’s an example of how a big incumbent typically reponds to embrace a new category by leveraging existing strengths.

So these are (3) variants of category creation as I see them. The point is to know what type of category opportunity you are working with so that planning and execution can occur appropriately. Each variant involves different risks, barriers and strategic considerations.

Finally, it goes without saying that category creation is not the only way to grow a business. The lion’s share of methods are product-level strategies and innovations. These are, naturally, the repeatable and recurring drivers of business growth. For example, product strategists consistently mine customer needs and behavior to identify ways to themes to drive the next wave of existing product adoption. But these types of innovations will not satisfy the growth agenda of today’s businesses. Market leading companies expect useful product and marketing refinements to occur because their existing success provides the customer access, resources and expertise to harness underlying insights. They’re already priced-in to some degree. This means increasing attention to category creation as a way to feed the expectations gap, which continues to grow.

If you have other categories that could fit onto the above lists, please feel free to share them.

• Reinventing innovation at consumer goods companies - McKinsey Quarterly;
• How companies approach innovation - A McKinsey Global Survey;
• The Granularity of Growth - McKinsey Quarterly

Filed under: Management, User Experiences, Web Apps, Innovation

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