Regulated industries beware. Disruption is headed your way, too. Companies whose incumbency has been protected by regulation face devastating competition from entrants none too concerned with pesky legalities.

Michael Porter, in his seminal book Competitive Strategy, proposed a model of five forces that can be used to analyze the attractiveness of an industry. While in business school at Harvard, I had the good fortune to address with Porter, a faculty member there, what I believed to be an important SIXTH force—regulation. We were discussing the airline industry at the time, and I argued that since some players yield relatively more influence over regulation, and since regulation sets the boundaries of the playing field, one cannot look at only Porter’s five forces to accurately describe a competitive setting

Over the subsequent two decades, scofflaws, aided by technological advances, have spurred disruptive innovation at a staggering pace. Regulation, viewed in Porter’s earlier works as of little competitive concern, is now at the heart of the matter.

Unsurprisingly, incumbents in the industries under assault don’t go down without a fight. Instead, they turn to the weapons that helped structure an industry in their favor in the first place. What they desperately want is inertia. They want the object at rest to stay at rest. It’s not that they are anti-innovation. They are anti-cataclysm.

The rules that built the industries were often designed to protect consumers from the risks posed by asymmetric information, monopoly power, or utter disdain for their well being. Certainly, some regulation was over-done or even wrong-headed. But, for the most part, the rules provided a safer, fairer marketplace.

Companies worked hard to shape regulations in ways that would not disadvantage them relative to competitors. If possible, advantages were sought. In the end, some equilibrium was reached—a set of boundaries within which Clay Christenson’s “sustaining innovation” could emerge, but where discontinuous change was unusual. Investments under these circumstances could be made with less risk. Profits were more predictable. Management approaches and organizational structures emerged to reliably turn out like quality products and services at standard costs.

Competing and prospering wasn’t easy, of course. But the rules of the game were better understood.

Over time, technology was adopted by incumbent competitors creating mainly marginal improvement at the customer level and to generate more profound impacts through internal efficiency. The spoils of these gains benefited the owners of the most powerful firms, at least until all the majors adopted the same, basic approaches.

Then, in the 1990s, technology not only advanced in power. It simultaneously rapidly decreased in cost. The competitive world became a bit more egalitarian.

What was the impact? What IS the impact?

  • Information asymmetry has become information transparency.
  • Monopoly power is shaken by upstarts.
  • Consumers’ well being relies more on individual diligence than government paternalism.

What emerges?

  • Medallioned taxis challenged by on-demand rides from Uber and Lyft.
  • The local record shop upended by file sharing and the iTunes Store.
  • The Bell System (once serving jacks in the wall) replaced by Apple and Samsung in collaboration with Verizon Wireless, Virgin, and Sprint serving customers who no longer use wire-line telephony.
  • Hotels challenged by homeowners and apartment dwellers renting their accommodations by the night through Airbnb.

Even old-line businesses like automobile manufacturing and sales are impacted. Tesla, the darling of the eco-friendly and growth investors alike, has run straight into incumbent protectionism. The company wishes to do what other successful companies have done of late—sell its innovative products directly to consumers. Yes, I know. Crazy talk.

The problem isn’t that selling products to consumers directly is at all radical. The most successful retail innovation of the last decade is, arguably, the (vertically integrated) Apple Store, known at once for terrific customer service and outstanding warranty support. The issue is that existing auto dealers are attempting to protect their business model from cataclysm. They fear, with good reason, that antiquated automobile consumer protection approaches, if shown unnecessary (or even inefficient: see http://www.ftc.gov/system/files/documents/advocacy_documents/ftc-staff-comment-missouri-house-representatives-regarding-house-bill-1124-which-would-expand/140515mo-autoadvocacy.pdf ), would lead to the unraveling of the entire distribution system on which their model relies.

So, instead of competing through their own innovation, automobile dealers are seeking legal and legislative intervention to secure the rents they earn from an industry historically protected by government action.

What makes these challenges troubling to incumbents is that consumers are demonstrating demand for the upstarts’ models in droves. The writing is on the wall. Industry dynamics are in flux. Regulation provides only fleeting refuge. Sooner or later, that old, warm, protective blanket will give way. And, it should. In a market economy, protecting industries’ sunk costs of adhering to outdated regulation is inefficient and anti-progress. Ironically, in these situations some measured phase out of regulation is actually supportive of consumer interests.

The problem for incumbents is that their market strength insulates them from upstarts for quite some time. Why is this a problem? Because the upstarts’ growing consumer support sneaks up on industry stalwarts. By the time incumbents realize that they face real threats, their ability to effectively respond is impaired. Too little is able to be done too late. And, like many telcos and record labels, the incumbents wither.

Whether regulation should have been included in Porter’s “forces” from the beginning is an open question. What is indisputable is that companies who continue to overly rely on regulation instead of their own innovation to secure their competitive position are running a substantial risk.

To learn what three industries are primed to be disrupted next, check back for the next post to this column.

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