Drunken Speculation

Why Craft Can’t Kill Big Beer

innovators dilemmaLast time I drunkenly speculated (actually, I was quite hungover) about the Australian craft beer market, I made a passing reference to disruptive innovation. Specifically:

It’s disruptive innovation: the small guys have been nimble enough to take advantage of the consumer’s general exhaustion with the business-as-usual approach of the multinats. Meanwhile, Lion and Fosters are scratching themselves, wondering what they’re going to do about it.

I shouldn’t have done so without reading The Innovator’s Dilemma by Clayton M Christensen. His book outlines why large, successful and well-managed companies fail to adapt some technological changes to their industry. He cites a range of examples, from hard disk drive manufacturers to excavators, motorbikes and big box retailers.

Fortunately, I was right that craft beer is a disruptive innovation but not for the reasons I thought.

I recommend reading the book but the fundamental thesis is that there are changes in industry called disruptive innovations. Disruptive innovations are typically new applications of old principles but re-engineered in a way that requires a new value-add chain (new ways of manufacturing, distributing, selling, etc) and the new offering puts an emphasis on different purchasing criteria compared to their predecessors (low weight or energy efficiency might be favoured over capacity or raw power).

Large existing companies, following managerial good practice, deliberately ignore these initially small and low margin markets to focus on existing customers and technology which appear to be more lucrative. However, as the new market develops, it eventually usurps the old, the companies who did not make the transition fail, despite the quality of their management and formerly secure position, while the companies who did make the transition continue to be profitable.

A poor but illustrative example is the rise of the smartphone. Fundamentally, the smartphone has the same functionality as its predecessor mobile phones but different value-add propositions (e.g. coolness or faster internet). This innovation and the resulting adaptive strategies from the incumbent mobile phone manufacturers has turned the mobile phone market upside-down. Whereas it was once the domain of Nokia and Blackberry, now the scene is dominated by Apple, Google and Samsung.

As such, craft beer meets most of the criteria for a disruptive innovation:

  • It’s still beer but the innovation came from outside the big brewers, searching for a market that may or may not have existed.
  • Craft brewing has a different value-add chain, as it is brewed on a smaller scale, marketed differently and predominantly sold in specialty pubs or at cellar doors.
  • It has a different customer base, one that is more affluent, interested in diversity and concerned with the origin of their beer as much as the taste.
  • The craft beer market is much smaller, catered to by brewers who are commensurate in size.

So if the disruptively innovative iPhone can kill Nokia, it looks like craft beer might be the undoing of big beer, right?

Unfortunately for those who hate Lion and Fosters, they have been remarkably foresighted in getting on board the craft beer train. Instead of standing in its way, Lion has picked up James Squire and Little Creatures, which includes White Rabbit and a minority stake in Stone & Wood, while Fosters has its Matilda Bay offerings. With the exception of Coopers, the multinats have a finger in every decent sized craft beer pie in Australia.

Note that the craft brands are able to operate with a degree of flexibility. They are clearly not expected to sell the same volumes as the mainstream brands and are able to pursue inventive lines of brewing and branding. By being judged by different criteria and being set apart from the mainstream breweries, Fat Yak, for example, won’t be shut down or forced to comply with corporate regulations because it doesn’t bring in the same revenue as VB. This is a surprisingly astute (or lucky) move. Operating a subsidiary, clear of the main company’s machinations, is outlined in The Innovator’s Dilemma as the only way to effectively (but still not reliably) ride a disruptive innovation.

What I think separates craft beer from hard drives is that craft beer, while much smaller in volume, has higher margins than mainstream beer. A typical disruptive innovation starts out as a lower margin product to a smaller market and so a less profitable path for a company to take, which is typically why well-managed companies prefer to assign resources to more profitable product lines. This may go some way to explaining why Lion and Fosters have been able to react with remarkable alacrity.

Does this mean that the craft beer market, with its extraordinary growth in participants, is viable? Not necessarily. Does this mean craft beer will take over the beer market? Probably not but one of the key drivers of disruptive innovation is that no one truly understands the potential size of the market. Only time will tell.

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