Skip to 0 minutes and 9 secondsWhen you think of innovation, what comes to mind-- creativity, success, advancement and progress for society? Innovation is all of these. But it also triggers the process of creative destruction, which is a concept introduced by Schumpeter, as we have looked at previously. In this context, innovation can be defined as a new idea or a new discovery that will then increase productivity-- in other words, help us produce more. It could be an invention that improves the production process, or it could be the introduction of a new technology that replaces part of the production line. Why would these helpful innovations be disruptive and create problems to those in the workforce?
Skip to 0 minutes and 51 secondsThe new invention of technology would prove to be better than the old way of doing things, and we'd undoubtedly replace it. So businesses, firms, and individual workers who use the old goods and technology will lose profits, market share, or rents, while those introducing the new goods and technologies will take a larger share of these. These are the winners who have used innovation to generate new markets and new business opportunities.
Why is innovation disruptive?
Innovation is disruptive when new technology replaces the old.
Let’s look at specific examples of industries that have been impacted by creative destruction.
The transport industry
Until the 19th Century, horses and mules were used for transportation. In the early 1900s, there were still 109,000 workers employed as carriage and harness makers in the United States. It was because of steam power that we saw the introduction of the steam locomotive (train) which allowed railroad transportation to expand and become a popular form of transport. By 1920, it is estimated that more than 2 million U.S. workers were employed in railroads.
Next, a great technological advancement was achieved with the creation of the internal combustion engine which eventually led to the appearance of the automobile (cars). This truly transformed the transport industry and helped it flourish to the point where long-haul trucks and airplanes came into existence. As a result, employment in railroads progressively reduced until the current 200,000 units.
The music industry
You may remember T.V. shows like Happy Days where we saw households use record players with vinyl records to play music. Then, in the early 1980s, cassettes took over, which caused great disruption for the firms who manufactured vinyl. We saw the numbers of these firms drastically drop. In the 1990s, cassettes were replaced by compact discs (CDs).
Finally, in the 2000s, digital downloads have become the most used (in fact, almost exclusively used) technology to listen to, purchase, and exchange music. In this process, profits (ie rents) passed from traditional music companies and manufacturers like Philips and Sony who produced the recorded versions of music to new companies like Napster and Apple who have the digital platform to host and sell this music. In this disruption we see a shift in who profits the most from the industry.
The movie industry - Netflix
Do you remember watching movies on video? How about on DVD? Did you used to go to a video store to rent your movies? The US video tape and DVD rental industry grew from 80,000 employees in 1985 to more 160,000 employees in 1999. Blockbuster alone employed 60,000 people in the early 2000s.
How do you watch movies now? We have seen plenty of video rental stores close all because Netflix entered the market. They introduced the streaming of videos online and this has caused a rapid decline of the video/DVD rental industry, which today employs only 11,000. But the so-called “Netflix effect” is not limited to video rentals. In fact, those who had moved on to using pay-TV are also steadily replacing this with Netflix streaming. Who loses? Traditional media companies have see a great reduction in their profits as a result.
How small companies can beat industry giants
Let’s now look at examples in this video to find out how small, young companies can beat industry giants and disrupt the market with their innovation.
This is an additional video, hosted on YouTube.
The key point
In all these examples, the new invention (eg digital technology, steam power and engine) allows a more efficient production or distribution of goods and services (eg faster transportation, cheaper access to music, etc…). As a result, users switch from using the old goods or services to using the new replacements.
Firms that are unable to adopt the new technology disappear (eg Blockbuster, which apparently was offered the possibility to purchase Netflix in the early 2000s, but passed on this) and jobs are “recycled” from the old firms to the new ones.
This raises an important question, which we will look at next:
How is innovation generated and brought into the economy?
Watch the video above and read through the examples of industries impacted by destruction.
Then, click on the comments and share your answers to the following questions:
- If innovation is necessary for economic growth, but also causes destruction, what should society do to protect those adversely affected in the transformation process?
- What is another great example of creative destruction you can recall? Tell us how this innovation caused disruption in the market.
Before moving on to answer these questions, you might also like to find out more by reading the article in the ‘see also’ section below.
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