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Startups vs. Incumbents: Disruptive Innovation in Alternative Protein

The history of business is filled with stories of small, under-resourced startups transforming industries by beating powerful incumbents. How is this possible? One explanation lies in Clay Christensen’s seminal book, The Innovator’s Dilemma, where he describes the theory of new market disruption.

I previously looked at the alternative protein industry through the lense of Clay Christensen’s other notable theory: the theory of low-end disruption. In this post, I’ll do the same for the theory of new market disruption [1]. I’ll first describe how new market disruption happens, then I’ll apply the theory to the plant-based and cell-based meat industries.

How Startups Beat Incumbents

The theory of new market disruption explains one way that under-resourced startups can beat powerful, competent incumbents. Some examples from recent history: brick and mortar retailing was disrupted by e-commerce, desktop computers were disrupted by laptops and then smartphones, the transportation industry was disrupted by Uber, etc.

According to the theory, there are two types of innovation: sustaining innovation and disruptive innovation. Sustaining innovation, the more common of the two, involves companies improving products to better serve their core customers. Some examples from tech include Amazon’s one-day shipping or Apple’s Macbook trackpad. Sustaining innovations in the meat industry include improved modified atmospheric packaging in order to keep meat fresh for longer, or new breeds of broilers with genetics optimized to improve feed efficiency, making the end product cheaper. Incumbent companies are generally advantaged in this type of innovation, since they can invest more into R&D, and have pre-existing customer relationships.

Disruptive innovation, on the other hand, is what causes new market disruption. Since incumbents dominate existing markets, startups are forced into smaller niche markets that incumbents aren’t focusing on. Startups cannot match the product quality of incumbents because they are under-resourced. Their products are “worse” under traditional metrics. However, startups can find consumer niches with different values than the average consumer, allowing them to get a foothold. Since incumbents are focused on their core consumers, startups can survive in niche markets with non-traditional products [2]. For example, a startup may not be able to make a computer as powerful as incumbents, but they may be able to make a much less powerful, but smaller computer that appeals to a certain subsegment of consumers.

Over time, the startup continues to improve their product through their own sustaining innovation. At this point, they are considered a niche player in the broader market. However, as they improve their product, they begin to expand their consumer base past the early adopters. Incumbents might try to move in, but the startup’s head start gives them an advantage that makes up for their comparative lack of resources. Eventually, the new paradigm proves to be dominant [3] over the old paradigm, and the startup beats the incumbent in the broader market.

The important part about this model is that you can assume that incumbents are competent and intelligent, even if they fall prey to disruption. This is because incumbents aren’t competing against a single startup–they are competing against the entire startup ecosystem. Startups start with no customers and no resources, and are therefore forced to take risks that would be irrational for an incumbent, who has everything to lose. The startup ecosystem as a whole can hedge this risk by tolerating most startups failing. Under the model of new market disruption, if an incumbent and a startup started in a new market at the same time, the incumbent would dominate with their greater resources. However, incumbents could never take the risk of abandoning their core consumer for a niche market.

A Simplified Formalization

To make the theory more concrete, we can create a formalization of new market disruption. This formalization will show that the fundamental problem faced by incumbent companies is that their incentives force them into local optima.

Local Optimization problem.jpg

We start by thinking of the landscape of opportunities as a 2-dimensional terrain, with peaks representing profitable businesses. Each business has a location on this terrain and tries to move as high as possible.

Within the terrain, a company’s height relative to their competitors determines their success, which in turn determines how many resources they have access to. Additionally, companies can invest resources in sustaining innovation, moving them up the slope that they are currently on. Christensen calls this “good management” [4]. Once an incumbent is ahead on a slope, it can be difficult for its competition to catch up.

Local Optimization problem with startups.jpg

A startup necessarily starts at the bottom of the terrain. Their goal is to build their business so they can reach higher levels relative to their competitors.

Importantly, companies can’t see very far up their own slope. Each startup thinks that they are at the bottom of a large peak.

This also helps explain why it’s difficult for well-run incumbents to resist disruption. In order to compete in the early days of a market, they have to move to the bottom of a new peak, but they won’t know ahead of time how high the peak goes. The startup ecosystem as a whole has an advantage, since it can tolerate many startups failing.

Indeed, many of the startups in the ecosystem eventually die. However, it takes just one company finding an even higher peak to disrupt the incumbent. By the time the incumbent realizes that there is a higher peak elsewhere, the startup will already have a head start, giving them an advantage in the new market.

Local Optimization problem with winners.jpg

Zooming back out

This is not a general theory of how all startups succeed. Rather, it’s a model of one way that small companies can outcompete powerful incumbents. There are plenty of startups that don’t match this pattern. For example, a startup can succeed with some particularly insightful sustaining innovation, coupled with explosive growth and a strong brand, e.g. Chobani. Additionally, incumbents can also achieve disruptive innovation, e.g. Apple’s iPad.

How then can we tell whether something is disruptive innovation rather than sustaining innovation? The best signpost is whether the target audience starts out as a niche subsegment of the incumbent product’s consumer base. Starting out with early adopters while the product is being developed is what allows newcomers to get a head start on incumbents. This will be an important point when we apply the model to alternative proteins.

Once we know an innovation is disruptive, what else do we know? It’s not the case that disruptive innovations are more likely to succeed, to take over the entire market, or even to be the most impressive. The main difference between disruptive and sustaining innovation is what kind of companies are naturally advantaged: the startup ecosystem is advantaged in disruptive innovation, and the incumbents are advantaged in sustaining innovation.

Tech example

To make the theory more concrete, we can look at an example that everyone will recognize: Uber.

Screen Shot 2019-05-08 at 4.14.36 PM.png

This is an actual slide from Uber’s original investor deck. Humorously, their “Best-Case Scenario” was a billion dollars in annual revenue, which they’ve now more than 10x’ed.  

When Uber started out (back then it was called UberCab), their target consumer was executives who wanted a fast car service in cities that didn’t have large yellow taxi fleets. Even though UberCab was up market of conventional transportation options, their offerings were different than what most consumers wanted and the initial market was small, allowing them to avoid competition from incumbents. This allowed Uber to set up their core technology, and begin assembling a fleet of drivers. Eventually, economies of scale let them bring costs down and offer affordable transportation options to more consumers. By the time it became clear that Uber was going to be big, their head start was too massive for incumbents to compete. Now, it seems clear that yellow taxis will soon be a thing of the past.

Plant-Based Meat as Disruptive Innovation

I previously wrote that plant-based meat could be 100% of the market, and I still believe it. The theory of disruptive innovation gives a story of how this might happen.

The Beginnings of Plant-Based Meat

Tofurky in the early days of plant-based meat. Notice the “100% vegan” labels prominently displayed in the top corner of the packaging.

Tofurky in the early days of plant-based meat. Notice the “100% vegan” labels prominently displayed in the top corner of the packaging.

The early days of plant-based meat were all about vegetarians and vegans. Older meat replacement brands like Morningstar, Boca Burger, Tofurky, and Quorn created products for this niche segment, which was big enough to sustain a few medium sized brands. Their appeal wasn’t necessarily that they replicated the experience of eating meat. Rather, they matched the functionality of meat by making a savory, protein-rich product that could serve as the centerpiece of a meal.

Based on what the average consumer wanted, their products were “worse” than the incumbent products. However, for vegetarians, the products were substantially better since they contained no animal meat.

For traditional meat producers, there wasn’t a huge incentive to invest heavily in this segment because it was so small–only a few percent of Americans considered themselves vegetarian, and only a portion of those were interested in meat substitutes. This allowed smaller companies like Tofurky to establish themselves, develop their products, and build out their capacity.

This foothold with vegetarians allowed newer companies like Impossible Foods and Beyond Meat to improve the existing products and reach a larger consumer segment: flexitarians. Without an existing market, it would have been harder to justify funding their R&D. Impossible Foods likely couldn’t have existed without Tofurky.

The current challenge for market leaders like Impossible Foods and Beyond Meat is to continue expanding past the vegetarian niche into the broader market. This will depend largely on how much they can continue to improve their product so that it is competitive with animal meat.

Where Plant-Based Meat Might Go in the Future

Unfortunately, the model of disruptive innovation won’t tell us for sure where plant-based meat is going. The beginnings of a massive disruption looks the same as the development of a new niche market segment that will stay niche. (Companies can only see a couple steps ahead of them in the terrain. They don’t know ahead of time how high their peak is.)

Rather, the theory can retrospectively tell us: if Beyond Meat or Impossible Foods take over most of the meat market, how could they have beaten large incumbents? The answer is that they were able to get a head start on the new technology by focusing on a niche that wanted the food in its earliest forms.

Here’s what disruption could look like, if it happens. Plant-based meat companies continue to improve their products until they convince the most discerning meat eaters. They also expand their products into the many product categories that make up the meat market. In doing so, they gradually expand their consumer base. Over time, the meat industry becomes increasingly focused on them as a serious existential threat. The dominant meat producers might then try to compete (this is already sort of happening, which we’ll discuss later). However, the startups’ head start gives them an insurmountable advantage. Eventually, plant-based products improve past animal-based meat products by being cheaper, tasting better, and being healthier. Meat companies that fail to adapt to this market disruption gradually lose market share until they disappear entirely. This is all despite competent and intelligent management by meat producers.

This scenario is contingent on it being possible to continually improve plant-based products from where they are right now [5]. If this proves to be too difficult, then plant-based meat might remain a small segment in a broader market, similar to plant-based milk’s current situation, where they have around 13% market share.

How Incumbents are Reacting

Nestlé’s new brand of plant-based burger aimed at flexitarians, called the Incredible Burger

Nestlé’s new brand of plant-based burger aimed at flexitarians, called the Incredible Burger

Arguably, the plant-based meat market has seen earlier interest from incumbents than is typical for disruptive industries. Some of the first plant-based brands are owned by large food CGPs: Morningstar is owned by Kellogg and Boca by Kraft. More recently, Tyson and JBS have announced plans for a new plant-based meat brand, and Nestle has started rolling out their new Incredible Burger. Additionally we’ve seen a number of high profile investments from incumbents–Beyond Meat’s investors included Tyson, Cargill, and General Mills.

I’ll first note that investment in plant-based meat means different things for different companies. Companies like Kraft already have large, diverse portfolios of products that target different customer segments. The rise of plant-based meat does not threaten its core business. Tyson, on the other hand, is primarily a meat processor that has some CPG brands, so the rise of plant-based meat more directly challenges their core business.

There are a couple of hypotheses for why incumbents may be paying more attention to this space than normal:

  • Meat companies are already huge, and are seeing diminishing returns in their core markets since US meat demand is relatively stagnant. Instead of participating in zero-sum competition with other companies, it may make more sense to look elsewhere for growth, such as investing in niche product categories. In theory, disruption is easier when incumbents see room for growth in their core business, since they are more likely to keep their attention on obtaining this growth.

  • The CPG industry incentivizes companies to carry a large number of brands, each targeted at particular customer subsegments. Historically, consumer goods have been sold through large retailers. In retail, there is a finite amount of shelf space that the retailer must divvy up among its suppliers. By increasing the number of brands a single CPG supplies to the retailer, the CPG is simultaneously increasing its shelf space, and taking away shelf space from competition. More brands also means more bargaining power with retailers. As a result, it’s possible that large food companies would have invested into brands that wouldn’t stand up on their own. The rise of e-commerce has made shelf space effectively infinite, dampening this incentive. However, since food is perishable, it is lagging behind other product categories in its adoption of e-commerce. Therefore, large food CPG companies may still have an incentive to increase the number of brands they supply to grocery stores [6].

  • Meat companies are feeling pressure (from consumers, shareholders, employees, etc.) to revise their core business. The notion that meat is bad for the world is becoming more widespread, potentially causing meat producers to invest in plant-based meat. Their goal could be to improve public relations, or they could truly be trying to diversify.

It will be interesting to see the quality of the products that incumbents come out with. Analysis under this theory would predict that incumbents like Tyson and Nestle won’t be able to match the quality of the leading plant-based startups. However, if the products are comparable, this suggests that the head start that current startups have might not be useful in the long term.

Is Cell-Based Meat Sustaining or Disruptive?

Cell-based meat is a much younger industry than plant-based meat, making it more difficult to predict what will happen. However, the theory of disruptive innovation gives us a useful framework to understand the various ways the industry could play out.

The main difference between cell-based and plant-based meat is their molecular composition. Cell-based meat is made up of animal cells, just like meat from an animal. Plant-based meat is made up of proteins, fats, and sugars that come from plants, arranged to make the product taste and feel like animal-derived meat.

Since early plant-based products were so different from conventional meat in taste and texture, their initial target market had to be different. This made it so disruptive innovation was the only path (remember that the type of innovation is largely determined by whether the target consumers are niche consumer base).

However, since cell-based meat could be molecularly identical to animal-based meat, it’s not restricted to this path. Instead of a competing product like plant-based meat, it could instead be developed as a new way of making the same product, suggesting the path of sustaining innovation.

In theory, if cell-based meat turns out to be a sustaining innovation, then incumbents will have a strong incentive to move into the industry early. This eats into the head start that startups need to beat incumbents.

There are a number of factors that could influence which of these two paths cell-based meat goes down. One is consumer acceptance–in order for meat producers to keep their current consumer base, the average meat eater will need to accept cell-based as a new way of making the same product. Even if cell-based meat is identical to animal-based meat in taste and texture, consumers may still avoid it, just like many avoid GMO soybeans. In this case, incumbents would have a smaller incentive to invest in R&D, suggesting the path of disruptive innovation.

However, I don’t think consumer acceptance will ultimately determine whether startups or incumbents are advantaged in the industry. It’s not a large enough moat to protect startups from late incumbent entry. If there are no other barriers to entry, incumbents could still move into the space and outspend startups whenever the market is large enough that such a move would be profitable [7].

A more important factor is how difficult scaling the technology proves to be. If the technology is “easy” this will push it down the path of sustaining innovation. If it is “hard”, this will push it down the path of disruptive innovation.

Easy vs. Hard Technology

The harder cell-based meat technology is, the longer it will take for there to be cost-competitive alternatives for a large number of meat products. Roughly speaking, if this happens in the next couple of years, then cell-based meat is easy based on my definition. If it will take many decades, then the technology is hard.

Easy technologies are often sustaining innovations since companies can develop them internally before releasing them to their entire consumer base. Hard technology, on the other hand, tends to be disruptive. It’s difficult for an incumbent to invest many decades of R&D into a technology before they see any returns [8]. Instead, startups can find consumer niches that are interested in an early version of the product too rudimentary to appeal to the average consumer.

How Will Cell-Based Meat Play Out?

The fundamental difficulty of the technology will therefore determine which innovation path cell-based meat goes down. This in turn will determine what kind of companies are advantaged in the industry. If the technology is easy, then incumbents will be advantaged, since they can invest many more resources into R&D than startups. If the technology is hard, then startups will be advantaged, since they can get a head start on R&D before incumbents have strong incentives to compete.

What would the sustaining innovation scenario actually look like? It might be difficult to imagine this, since the field is currently pioneered by young startups. If, after a couple years of R&D, large food companies or biotechs come to believe that scaling the technology is feasible in the short term, then they might spin off their own cell-based meat initiatives. At this point, we may see acquisitions of pioneering startups by incumbents trying to compete with other incumbents. The theory of new market disruption suggests that startups would benefit by being acquired, since they would gain access to the incumbent's extensive resources and consumer base.

Many companies are considering foie gras as the initial entry point to the meat market given its high price and homogenous texture.

Many companies are considering foie gras as the initial entry point to the meat market given its high price and homogenous texture.

On the other hand, if the technology is hard, this has major strategic implications for cell-based meat startups. If the technology will take 15 or more years to be competitive with high-end animal-based meat, then startups likely can’t completely rely on venture capital to fund R&D. They will need to find a business model that can monetize their technological progress sooner. The goal would be to get a foothold in a niche segment to sustainably fund R&D until they are eventually ready to go to market with a competitive meat product. By this time, they will have large, protectible head start over incumbents.

The stepping stone product would ideally involve large scale mammalian or fish cell culture so that technical infrastructure can later be used to make meat. The following is a non-exhaustive list of products that a startup could create on its way to full cell-based meat:

  • Hybrid plant-based / cell-based meat products. This is something that many in the industry already talk about. If it’s possible to see substantial product benefits from a small percentage of cultured cells, then cost-competitive hybrid meat products could be feasible while the price of cultured cells is still high [9].

  • Starting with high-end meat products that are typically sold in small volumes, e.g. foie gras. Many companies seem to be already pursuing this strategy.

  • Developing meat products that the current meat industry would have trouble supplying. For example, large amounts of extra-ocular muscle meat (the muscle that controls eyes), or exotic meats like lion and alligator.

  • Cell-based nutritional supplements. For example, using animal cells to provide vegetarians and vegans with nutrients that they might lack due to not eating meat [10].

  • Cell-based food additives. For example, a low-volume ingredient that can be added to vegan cat food to provide the essential amino acids that make cats obligate carnivores.

  • Extremely expensive meat products that aren’t anchored to prices of their animal-based counterparts. For example, there might be a segment of consumers that would be interested in a luxury experience where they pay $100 per pound of high tech meat.

  • Cell-therapy based veterinary care for livestock (likely cattle, since they are the most valuable per head) or pets. This path should be used with caution, as making the beef industry more efficient might make it more difficult to compete in the long run.

I haven’t vetted most of these ideas thoroughly, so they should just be used as a starting point. If startups foresee long timescales for cell-based meat, it will be important to get creative with their business model in the meantime.

Which path is more likely?

Advocates for cell-based meat seem to want it to be a sustaining innovation. They emphasize the fact that cell-based meat is molecularly identical to meat, and sometimes show aversion to intermediate products like cultured / plant-based hybrids. This is understandable–if cell-based meat were truly a sustaining innovation, then it would be a no-brainer to fully adopt it once the technology is ready. Cell-based meat could be swapped out for animal-based meat behind the scenes, much like how animal-based rennet was eventually replaced by recombinant rennet without much fanfare.

However, given that this is a fundamentally new technology in a highly cost-sensitive market, I’m not sure this hope is justified. I think it’s prudent to prepare for cell-based meat having a long and difficult, but ultimately possible, path to market.

Take this with a grain of salt–I don’t have any special insight about what’s happening inside companies. For all I know, things could be going extraordinarily well.

Conclusion

I’ll make the same caveat that I made when discussing Christensen's’ model of low-end disruption: this is a theoretical model, not an empirical truth. Models can help retroactively explain facts, or generate hypotheses about unknowns given a structural understanding of the phenomena. However, in the real world, there’s always random noise, and competition in business tends to select for outliers. If I were to make a prediction about what will actually happen in the industry, it would take into account this model, but it would also incorporate many other models and considerations.

There are a couple ways in which alternative proteins could diverge from the predictions of the theory of new market disruption:

  • “Meat” might be best understood as a collection of disparate markets, each with unique market forces. For example, cell-based meat may be disruptive for ground beef, but sustaining for a more expensive cut such as sirloin steak.

  • As mentioned in the discussion of plant-based meat, incumbents seem to be taking an interest in both plant-based and cell-based meat earlier than is typical for potentially disruptive technologies. This could dampen the power of the startups’ head starts.

  • Hybrid meats might intertwine the fates of the two industries, changing the calculus as to whether startups or incumbents are advantaged.


Thanks to Alene Anello for feedback on drafts of this post. What path do you think plant-based cell-based meat will take? Let me know in the comments!

Endnotes

[1] I focused on new market disruption second because I find it more difficult and nuanced than the theory of low-end disruption. Unfortunately, new market disruption can be caricatured as “bulky incumbents have blinders that make them unable to see shifts in their core market, causing them to be disrupted by nimble startups.” I think this misses a lot of the subtlety and beauty of the theory. The actual theory is both narrower and more useful, and hopefully I’ll be able to draw this out through the formalization in this piece.

[2]  In Christensen’s original theory, new market disruption always starts at the low end. As a result, companies like Uber, which started with high-end black car services are not truly disruptive. However, I think this is unnecessarily restrictive. It’s sufficient for new market disruption (or at least my interpretation of it), than new products win along different metrics than incumbents, lower price and quality being one special case of this.

[3] I think dominance can be achieved in a number of ways. For examples, product improvements can eventually allow the new product to beat the traditional product based on the original consumers’ values. Or, the new product can gain enough market share that the old product can no longer utilize the necessary economies of scale to survive. This latter path to dominance is the most likely way that plant-based meat would become dominant.

[4]  This term confused me initially–even if managers can achieve short-term growth by focusing on sustaining innovation, wouldn’t even better management try to avoid disruption? I think Christensen would agree with this, and in fact meant something narrower. “Good management” has more to do with what’s good in the average case, i.e. when disruption isn’t on the horizon. This is focusing on your highest value customers, mitigating risks, increasing margins, etc.

[5] The most important point is that plant-based meat surpasses animal meat based on the value function of consumers. Taste is likely the most important input to this function, but it is not the only one. It’s possible that small deficiencies in taste could be balanced by large surpluses in another characteristic, e.g. nutrition, price, or sustainability.

[6] Ben Thompson provides great insights about this effect here.

[7]  Put another way, consumer acceptance of cell-based meat is a communal good that affects every startup in the industry. Technological barriers, on the other hand, only affect the company that owns the technology. Late entrants could free-ride off the work of earlier companies that acclimated consumers to the idea of cell-based meat.

[8] If cell-based meat turns out to be a hard technology, it’s path may look similar to animal farming. High-density animal farming started in the US in the middle of the 20th century. Since then, it has undergone many decades of innovation, including major developments in animal nutrition, veterinary care, and genetics. Alongside this growth was the development of important supporting industries like cheap corn and soy for feed. All of these developments have brought the cost of meat production down to what it is today.

[9] I’ve previously argued that we ought to develop hybrid plant / animal based products now,in order to prepare for this possibility.

[10] There is plenty evidence that vegetarian and vegan diets are perfectly healthy. However, given the complexity of human nutrition, there is always a risk that there are important nutrients in meat that we are not aware of. For example, there is preliminary evidence that creatine could be important for brain function, yet few vegetarians supplement this molecule. Using animal cells as nutritional supplements could mitigate this risk, since any molecule in meat could be found in the supplement.

Robert YamanComment