Thursday, November 19th, 2009

Ryan Avent: Disruptive Technologies

[ For those who don't already read him, Ryan Avent is an editor at The Economist magazine who also writes for Streetsblog Capitol Hill and at his own blog The Bellows. Ryan is also an honest to goodness real economist too. He's great for getting a more progressivist take on urban issues from the perspective of an economist, and you'll often find him jousting with the likes of Ed Glaeser. I've been reading Ryan a while and he's great. It was also great to get to meet him and person and be part of a panel with him at Rail~Volution 2009. I recommend checking his blog out.

This post ran on his blog back in August. Though I subscribe, I somehow missed it until reminded of it by Jim Russell. I thought you all would find it interesting so I am reprinting it here with permission. ]

Disruptive Technologies by Ryan Avent

I’ve been enjoying Tim Lee’s posts discussing the introduction and impact of a disruptive technology. Let me quote some (a lot) of what he’s been writing:

The key characteristic of a disruptive technology is that at its introduction, it is markedly inferior to the then-dominant technology, as judged by the existing base of customers. A classic example is the microcomputer. When the first microcomputers were released in the late 1970s by Apple, Commodore, and others, they were inferior in almost every respect to the minicomputers and mainframes that then dominated the computer market. People bought microcomputers for one of two reasons: they couldn’t afford a minicomputer, or they had an application where the microcomputer’s unique advantages (i.e. smaller size) were a particular advantage.

It’s important to understand that the innovator’s dilemma is not that disruptive technologies are “so innovative” that incumbent firms can’t keep up with them. To the contrary, disruptive technologies are often relatively pedestrian from an engineering point of view. Minicomputer manufacturers would have had no difficulty entering the microcomputer market if they’d wanted to. Rather, the innovator’s dilemma is that incumbents find it extremely difficult to make disruptive technologies profitably.

He quotes Clayton Christensen:

A characteristic of each value network is a particular cost structure that firms within it must create if they are to provide the products and services in the priority their customers demand. Thus, as the disk drive makers became large and successful within their “home” value network, they developed a very specific economic character: tuning their levels of effort and expenses in research, development, sales, marketing, and administration to the needs of their customers and the challenges of their competitors. Gross margins tended to evolve in each value network to levels that enabled better disk drive makers to make money, given these costs of doing business.

In turn, this gave these companies a very specific model for improving profitability. Generally, they found it difficult to improve profitability by hacking out cost while steadfastly standing in their mainstream market: The research, development, marketing, and administrative costs they were incurring were critical to remaining competitive in their mainstream business. Moving upmarket toward higher-performance products that promised higher gross margins was usually a more straightforward path to profit improvement. Moving downmarket was anathema to that objective…

Four times between 1983 and 1995, DEC introduced lines of personal computers targeted at consumers, products that were technologically much simpler than DEC’s minicomputers. But four times it failed to build businesses in this value network that were perceived within the company as profitable. Four times it withdrew from the personal computer market. Why? DEC launched all four forays from within the mainstream company. For all the reasons so far recounted, even though executive-level decisions lay behind the move into the PC business, those who made the day-to-day resource allocation decisions in the company never saw the sense in investing the necessary money, time, and energy in low-margin products that their customers didn’t want. Higher-performance initiatives that promised upscale margins, such as DEC’s super-fast Alpha microprocessor and its adventure into mainframe computers, captured the resources instead.

Now, here’s Lee again:

But companies aren’t big people, and it’s a mistake to think of them that way. In 1983, any given engineer at DEC could have easily quit his job making minicomputers and taken a job at Apple or IBM making microcomputers. But it would have been much harder for DEC as an institution to make that same transition. Turning DEC into a microcomputer company would have required a wrenching, years-long struggle to essentially build a new company from the ground up. Indeed, as Christensen documents, the few firms that have successfully pulled off such a transition have done it by essentially growing a new company inside the existing one: senior management would start a subsidiary devoted to the disruptive technology and keep it insulated from the parent company’s managerial structure. The hope was that by the time the parent company fell on hard times, the subsidiary would hopefully have grown enough to sustain the overal company’s profitability. There are a few examples of this strategy working, but it’s an extremely risky and difficult process.

Me being me, I read this and instantly began thinking about cities. One of the things I’ve been puzzling over recently is the implosion of formerly successful metropolitan areas. In theory, there’s no reason why the decline of one of a city’s principle industries should lead to the decline of the city itself; cities have useful infrastructure, institutions, and human capital, and the decline of one industry should free up space that can be utilized by a new, growing industry.

In practice, things tend not to work out this way. Cities that face the loss of one of their main industries tend to suffer through a long period of decline before recovering, if in fact they manage to recover at all. Why is this? Why should all of the many things that go into the making of city come undone in one place just because one particular business failed, while all of the things that go into the making of a city are rebuilt from nothing elsewhere in the country? It makes no sense.

I have tended to focus on negative feedback loops as a primary explanation for this dynamic, and I feel certain they play an important role. Loss of part of a city’s tax base will lead to reductions in the quality of services and increasing tax rates, which will lead richer households to leave, further shrinking the tax base. Declining services lead to failing schools and high crime rates which accelerate depopulation and so on. A city’s most talented workers will have the most opportunity available elsewhere, and so they’ll be the first to leave, sharply reducing an area’s competitive attraction, thereby encouraging further talent to leave, and so on.

Ed Glaeser has argued that it’s very difficult to recover from depopulation because of the durability of the housing stock. Falling population alongside steady housing supply leads to falling home prices. This, in turn, attracts those who require cheap housing — the poor — which will further degrade housing values and attract more poverty. An increasing population of poor residents will also tax city services which will further imperil budgets, and so on.

That certainly seems like enough to destroy a city, but it isn’t. In real life, cities experience negative shocks all the time, but they don’t always enter into a major downward spiral. And some cities which do face a downward spiral manage to pull themselves out of it and enjoy an economic renaissance. Why?

I think Lee’s disruptive technology post offers us a glimpse at an explanation. When a metropolitan area has an old, successful, established industry as its economic driver, that area builds its infrastructure and institutions around that industry. These institutions are likely to be unwilling and unable to accomodate and support growth industries. We can think about legislators in a Rust Belt state who fight to protect old industries even when the protections they seek would undermine growth industries. Or banks in old manufacturing centers that are reluctant to invest in start-ups with sharply different practices from the old giants.

If you have a daring new idea, you don’t take it to someone who’s living fat off something which has worked for decades. You take it to someone who is hungry. Many of the Sunbelt boom towns which have sprung up over the past half century grew at the start by accepting what investment they could. I’m reminded of my hometown, where leaders were anxious to attract high-tech investments to their new Research Triangle Park. It was lack of better options that gave them the idea in the first place — something which might not have occured to leaders in a city where hundreds of thousands of people earned good union wages in manufacturing plants. And while leaders definitely wanted to craft a research environment, they took the investments they could get. Not having recently been on top of the world, they had the benefit of not suffering from wounded pride when less-than-glamorous operations came to invest.

And I think there’s something to the idea that new growth cities aren’t inherently superior to older, richer metropolitan areas. Rather, their advantages are fairly mundane — they’re cheap, accommodating, and ready to please. On the other hand, older, richer cities don’t realize that they have a problem until it’s clear their bread and butter industry won’t ever be the same, at which point they’re faced with serious problems and have few resources to attract new industries. At that point, there are few routes to recovery. A city might get lucky (by, say, enjoying proximity to another metropolitan area which enjoys a booming economy). It might manage to retain enough in the way of resources from niche industries, like tourism, to maintain a framework capable to supporting a new growth industry. Or it might find that one of its older and smaller industries is capable of growing large enough to fill in the missing economic strength.

There are tricky implications to this. It suggests, for instance, that the availability of new metropolitan areas is crucial in maintaining a flexible, growing economy. That creative destruction doesn’t just mean the scrapping of once-proud firms but of whole cities. It also suggests that my previous prescription for fighting urban decline — a program of temporary fiscal support — could be counterproductive. It might delay inevitable economic adjustments.

I don’t know that I accept that it’s necessary to destroy old cities and create new ones to keep an economy fresh. Revolutionary geography could be interchangeable with institutional or political revolution. That is, places that are less flexible geographically might instead face increased pressure to change institutions or otherwise accommodate disruptive economic change. Still, this seems to be an important part of the story of urban decline.

Related on The Urbanophile

Creative Destruction is Real
On Innovation
Resolving the Paradox of Success

Topics: Economic Development, Globalization, Public Policy, Strategic Planning, Sustainability

8 Responses to “Ryan Avent: Disruptive Technologies”

  1. David says:

    Agreed that the tables can turn rapidly. As the article says, the Research Triangle innovated in the 1950s because it lacked better options, but now, the cities of the industrial heartland that have lost 30-50% of their population and much of their industrial raison d’etre since WWII all realize they’re in a life-and-death struggle. They will innovate, too, because they have no choice. The ones with strong and imaginative business and philanthropic communities will get there first, but nearly all are trying. BTW I’ve put together an Amazon a-store on the literature of urban decline here: as part of a broader collection on technology-based economic development all linked to my site.

  2. Ironwood says:

    Agreed. We are still working with relatively short cycles here in America with our cities. 50 years is a blink when one thinks of European or Asian cities. It’s entirely possible that cities will need to go through fallow cycles, just like neighborhoods, only to be rediscovered and re-invested in at a later date. (An analogy would be the re-use of obsolescent multi-story loft factories which have enjoyed a massive re-purposing). The analogy is not perfect, but it doesn’t need to be. The point is that a generation or two of decline in some cities — and rapid growth in others — is just not enough time to write any urban obits.

  3. DaveOf Richmond says:

    This post reminded me of a passage I read a few years ago in a book called “The Rise of the Gunbelt”, which I just dug out and found again, where the authors talk about Northwestern University’s Albert Rubenstein’s study of Chicago’s electronics industry in the early Sixties, and why it wasn’t getting more Federal money for the burgeoning aerospace and defense electronics programs of that time.

    He concluded that “business was excellent” for existing electronic firms in their old areas of expertise, and they weren’t “geared” for all the gov’t red tape, plus Chicago bankers were content with their current clients and were “indifferent, if not hostile, to small research-based enterprises”.

    Sounds mighty similar to what is being described in your (Ryan’s) post, and Rubenstein’s study was in 1962, so at least some people have recognized this dynamic for decades. Does anyone ever learn from it?

    At this point perhaps it’s just as well for Chicago to have largely missed out on the big defense aerospace/electronics biz, as the city is doing rather well now, and those industries have since picked up and moved from some of the places in which they centered back in that era (Los Angeles for instance).

    Anyway, I like your blog and also many of your reader’s comments.

  4. Wad says:

    Cities that face the loss of one of their main industries tend to suffer through a long period of decline before recovering, if in fact they manage to recover at all. Why is this?

    It’s quite an old phenomena. It’s inertia.

    If cities continue to specialize in a key industry that has made them wealthy, it tends to focus on that emphasis until its momentum can no longer be sustained.

    Detroit and Pittsburgh are the industrial equivalents of a supply region. So many jobs and business transactions depended on cars and steel that it was too late to shift into another economic sector by the time those industries had diminished.

    The people working in those jobs had not gained appreciable skills they could port to create some other value function and business transactions had shifted elsewhere.

    The world is also littered with boomtowns that arose to extract resources (mining towns, logging camps, old fishing villages, etc.) then deactivated when the resources had been exhausted.

    Even telling was where the modern cities of their time developed. Very few feudal agricultural lands evolved to important cities. The earliest cities sprouted near bodies of water.

    Feudal lords were loath to adopt to capitalism, as they saw their land and serfdom as the plentiful bounty that nourished their well-being and influence. Instead, these early cities were able to produce wealth through trade. Soon, one hectare of city land produced exponentially more wealth than a hectare of cropland.

    In turn, it enabled a new category in the social order. The term used to be “middle class,” but today it has been simplified to mean an income cohort. The original middle class actually referred to a social function. The middle classes toiled, but they were not serfs. The middle classes possessed some property, but they were not nobility. They managed to create a social hierarchy and set up learning methods, but they were neither monarchy nor clergy. They were somewhere in between these other classes.

    This is the precedent to the statement, “If you have a daring new idea, you don’t take it to someone who’s living fat off something which has worked for decades. You take it to someone who is hungry.”

    That is how cities came to be.

  5. John Howard says:

    While the new site design is very nice, the font is horrible. The ‘Metabook’ and ‘Metabold’ fonts are apparently simulated under Firefox on Windows (having seen your complaint on the old blog about HTML5 failings in IE, I opened this in FF).

    The pages render extremely-ragged text that is quite difficult to read. IE, however, is clean and contrasty. It’s very readable with IE.

    The ‘Meta*’ fonts are a very poor choice.

  6. Rob Ross says:

    Bloggers we might want to invite to Christmas party

    Greg Blankenship from the Illinois Review. 217-306-5226
    Pete Speer from Illinois Review. He wrote a long challenge to IPI about high Speed rail.
    Chris Robling from Illinois Review.
    Carl Oberg is a Policy Associate for Americans for prosperity. His contact info is not listed on AFP’s site, but I’m sure he can be contacted through channels.

    The phenomenon you observe, that older cities seem to decline in productivity as the original industries decline, is encouraged by land regulation and the under taxation of land in urban centers. Landowners are have a positive incentive to withhold land from production, preventing new industries from forming and holding back urban progress. Cities with high taxes on land and low taxes on production and consumption experience a much higher rate of urban renewal.

  7. Marshall says:

    I’ve been reading Thomas Kuhn “Structure of Scientific Revolutions”, which talks about how new paradigms emerge from a period of dithering, and how it’s very difficult for practitioners of the old paradigm to incorporate the insights of the new, despite the accumulation of “anomalies”. Seems this pattern is quite generic in the evolution of human culture: language, religion, urbanification.

  8. Thanks for all the great comments.

    John Howard, I reached out to you directly about the font issue. Email me if you don’t get my note.

    Kuhn’s “Structure of Scientific Revolutions” is a must read. I think human beings are frankly hardwired to see the world through a “paradigm”. Even Kant argued as much with his “a priori” knowledge. Perhaps the knowledge itself is somewhat socially constructed, but we seem to have a “world view” that is incredibly resistant to change and through which we process everything.

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