Is the cloud the ultimate disruptive innovation? by Aaron Levie @FortuneMagazine September 27, 2011, 6:44 PM EST E-mail Tweet Facebook Google Plus Linkedin Share icons FORTUNE — Fans of Clayton Christensen’s “Innovator’s Dilemma” will be unsurprised that the formula is still alive and well, even in 2011. Yes, apparently innovation still matters. To see the original effect in action, look no further than your desktop. How much desktop software do you generally use on a daily basis? Now, compare that to how many services you — and your company — are using in the cloud, delivered over the web. If you’re like most business people, for the past two decades you’ve been dealing with slow, painful and cumbersome applications to help run your projects, manage your customers and share files. Installations of software tend to take months, maintenance costs more than the original product price, and unexpected delays and down time result in a massive drop in productivity. But all this changes with the cloud. Cloud-delivered enterprise solutions fit consistently and nicely into Christensen’s framework for “disruptive innovation.” They offer cheaper, simpler and often more broadly applicable alternatives to legacy models of enterprise computing. They tend to start out as low-end disruptors, bringing cost and performance advantages to over-served customers, but as these technologies mature in their reliability and sophistication, they’re spreading throughout organizations and solving some of the most demanding problems. Christensen must be gloating. All this spells very big trouble for the traditional enterprise software leaders who plainly know they need to make the leap, but don’t have the business models, DNA, or dire necessity to support the change today. Over $270 billion dollars are spent on enterprise software every year, but so far, only a fraction of those dollars is going in the pockets of cloud vendors. There just isn’t much explicit incentive for the enterprise stalwarts to move that aggressively to the web. Sudden and forceful movements may confuse customers, disrupt channels, transition economics inequitably, or lead to poor product execution. Hence the predicament. Why is cloud a disruptive innovation? Not all innovations are disruptive, of course. If a technology advance merely reinforces the position of incumbent vendors in a given category, it qualifies as a sustaining — rather than disruptive — innovation. If there are minimal changes with respect to business models and go-to-market strategies, or the technology advance is non-linear technology, existing market players are generally safe. In the memory business, for instance, improvements in performance (within a given range) are often sustainable by the leading storage providers. Whereas the introduction of an entirely new technology, such as flash storage, gives the advantage to new players who can capitalize on the opportunity and commercialize it more quickly. This, predictably, shows up time and time again. When the world wide web came along and Dell DELL launched the Dell.com website in response, it simply became another channel with which they sold the same products. The differences between a catalog and a website are insignificant if you take advantage of the Internet effectively. Yet every market is different: The Yellow Pages dropped a ball that Yelp picked up in the world’s move to hypertext, not because the web alone was a disruptive innovation for accessing local information, but because user-generated reviews were a brand new way to experience local guides. And a product like Yellow Pages that already lacked a community had none to transfer over to the new world. Nothing in this world nothing can be said to be certain, except death, taxes, and enterprise software disruption. In the ‘90s, the industry went through an upheaval as the client-server model displaced the mainframe. Describing PeopleSoft, and by extension the new wave of client-server computing, the New York Times in 1995 said, “tasks are split more or less evenly between desktop ‘client’ computers and larger machines.” This new (and now old) standard represented a cataclysmic shift in value, because applications could now be much more powerful and modern using PC standards, data could be mostly centralized, and everything would run at a fraction of the cost compared to mainframes. Fast forward a decade and a half, and the same large-scale change has occurred yet again with our most core business applications by bringing them to the web. Why is this such a fundamental change, and not one that the old guard can quickly latch onto? Well, because nearly ever dimension of the sales, marketing, distribution, and the utility of cloud-powered software is different than before. Sales and marketing are now tied to end-user adoption of services, not mandated top-down deployments of enterprise software. Distributing technology over the web offers current market leaders no intrinsic advantage that a startup can’t access – that is, the web is served up completely democratically, whereas software in the past was usually delivered via partners or vendors with the most extensive salesforces. Finally, the products themselves are nearly entirely different. Cloud solutions generally embrace a world defined by collaboration, mobility, and openness. And in a few software and hardware categories, traditional vendors are more or less forced out of ever supporting their customers through the cloud. Put yourself in the shoes of an incumbent storage vendor that has traditionally sold its hardware to IT buyers and service providers alike. When Amazon AMZN builds out its own storage that it can offer to developers and customers (which it has) because of the scale they’ve achieved, do you decide to compete with them by launching a cloud storage service? Most in the storage space haven’t, because they would find themselves competing directly with their other service customers. This leaves many vendors in the unenviable spot of having to finesse their business model like a game of Risk. Altogether, this gives startups a unique set of value drivers that allow them to compete with traditional powerhouses from a safe distance. Just as MySQL classically went up against Oracle ORCL without ever competing for customers, many cloud solutions today are similarly disrupting the older guard by initially slipping into the “just good enough” category. From there, product roadmaps become more elaborate, customers are served in more meaningful ways, and before you know it just good enough becomes great, and then better. Those who’ve watched Salesforce.com CRM over a ten year period have witnessed a striking example of this trend. In 2002, the then-upstart CRM had 2% marketshare of the global CRM space, and analysts often wrote it off, saying, “[Salesforce] doesn’t compare well at all with other large CRM packages like Siebel and PeopleSoft… they will almost always come up short on the functionality side of the equation.” In 2011, they’ll hit $2 billion in revenue and 100,000 customers, putting them on track to quickly be one of the largest software companies in the world. The same is happening with the next batch of enterprise software players in the cloud, where lower cost and fundamentally simpler applications have emerged as aggressors to the traditional enterprise stack. Workday, no longer a mid-market-only play, has quickly shot up market, closing deals with Time Warner TWX and Thomson Reuters, which is sure to ruffle some feathers in Redwood Shores and Walldorf. GoodData raised $15 million on the heels of over 2,500 customers realizing they can get business intelligence software at a fraction of the cost of solutions from IBM IBM and Oracle. And at Box, customers can store content often for a fifth of the cost of traditional systems, and then get to that information from any device, something that is universally impractical with an on-premise application. Similarly, many emerging companies are operating on dimensions that were never easy, possible, or necessary in a previous generation of software. Zendesk and Assistly have disrupted the support market by integrating more easily into the myriad of systems which now act as customer touch-points, something on-premise vendors have neither the technology nor wherewithal to do. Jive and Yammer take on traditional email and collaboration systems by incorporating an untouchable social and stream-like model that anti-social technologies from Microsoft unsurprisingly lack. Okta and Snaplogic help businesses connect their identities and application data together respectively. What do all of these services have in common? They’re all solving new problems that the incumbents not only can’t attack, they also can’t even begin to understand. But before they know it, startups will have pulled away significant market share as move more deeply into the enterprise. These new approaches and disruptive go-to-market techniques can get new enterprise software companies to scale at a speed only previously seen by technology aimed at consumers. Just like the last great wave in computing that occurred over two decades ago — putting companies like SAP SAP , Microsoft MSFT , and Oracle in the leadership positions they hold today — we are on course to see a new set of leading vendors. And along with this, the entire information technology landscape will change. A value shift across the enterprise IT ecosystem Many of the questions around what a utility computing world will produce pertain to the future of the IT function and services industries. When applications and infrastructure are delivered over the cloud, where do the business models of system integrators, ecosystem partners, and IT professionals go? With a direct-to-customer model, is there room to be a middle-man? I believe this is in the category of sustaining innovations for the current system integration firms, but with a lot of change to come. The business model remains very similar, but the execution and actual value provided moves higher up in the stack. Instead of hiring “experts” to do everything – from putting together servers, plugging cables into boxes, all the way to integrating and deploying applications – IT of the future will begin to support higher order problems. In the words of Accenture ACN senior executive Kevin Campbell, “[Cloud] provides the opportunity for the IT department to focus on delivering business value.” In the past, client budgets often ran out well before the successful integration of multiple systems, and long before a business could begin to truly build interesting value on top of the software and systems that they had in their business. This leads information technology experts to spend less time implementing and maintaining the basics of an IT strategy, and ultimately adding more value to the ‘core’ business processes of a company. Instead of working on the necessary but lower utility tasks like managing data, running email servers, and installing CRM software, IT teams and service firms can spend times in high leverage areas of the business. We’re seeing this happen across industry and markets with our customers. At Pandora P , its IT leads are freed up to integrate applications to produce better value, speed, and flexibility for their employees; at Dole, individuals can work from their iPads to pull down critical business information from anywhere; and at Procter & Gamble PG , their innovation-centric IT group is delivering the cloud to teams across the world, enabling them to work more productively from anywhere, and connect with other groups, securely. Because of all this change, customers are going to begin to experience a much more dynamic and democratic software environment. Solutions will be forced to update to the latest trends more regularly, and this will drive better business results for all enterprises. Work will be done faster, people will get more value from their technology, and the ecosystem will even grow as a result of the breadth, diversity, and reach of technologies availble. In a market as continually churning and revolving as information technology, one can easily marvel at how Microsoft and Oracle have maintained leadership for so long. But then again, the world hadn’t fully flipped over in the past twenty five years as much as it has today. Change is undeniably here, platforms are rapidly maturing, and now the disruptors of a previous generation must now decide whether they will disrupt themselves in the name of future relevance, or cling to old paradigms as new players emerge. –Aaron Levie is the CEO and co-founder of Box.net.