The concept of Exponential Organizations was introduced in 2014 by Ismail Michael S. Malone and Yuri van Geest, in a book by the same name. Organizations that are considered exponential grow at a much faster speed than companies that are known as linear companies. The figure below explains in a simple manner the difference between exponential companies and linear ones.
Linear companies have an organic growth, which is reached by an increase in production and sales. In other words, in order to grow it is necessary to sell and in order to sell more it is necessary to produce more. The only thing is that, for production to increase it is necessary to have more people, more machines, more investment – which will happen by opening new factories or through mergers or acquisitions. Therefore, this process will depend on capital-intensive investment, which may generate high risk if there are any unforseen variations in demand. The global reach for a linear company may take decades to attain, since it will be necessary to open new factories in other countries and then test the local consumer market for product approval, and apply modifications before finally growing.
Before we speak about exponential organizations, let’s talk about what disruptive innovations are. In order to understand this type of innovation, think about the following: who wouldn’t like to buy the latest Smartphone on the market? Basically everyone would. However, the cost is not feasible for most people. But if I can’t purchase that particularly ‘nice brand’ of phone I can buy another one, of a similar brand, that will do a lot of things that are also cool – at a much lower price. This alternative brand begins to grow since it begins to cater to a market that had not been served by the ‘nice brand’. Other than being similar and cheaper, the alternative product is also simpler and can be found at any store. One doesn’t have to go to specific places in order to buy it.
Disruptive innovation: simple, affordable and accessible
By reaching a much larger market, this similar company starts to grow much faster than the ‘nice brand’ company, and much of the time it is able to reach or even surpass it in terms of revenue.
And what are Exponential Organizations? We’ll answer that, but before, there is one more concept, a really simple one, which we need to talk about. This concept is called Economy of Scale. Think of the following situation: suppose that I decided to sell juice on my street. For that I purchased a 1-litre bottle of juice from concetrate and dissolved it in water and added sugar and, with this mix, I could pour up to 50 cups. If I were to sell only one cup, the price of this juice (in order for me not to be at a loss) would have to cost the same as everything that I bought. However, if I sell all 50 cups, I would only have to buy the remaining 49 cups, since I already have the juice, and if they are plastic cups they are even cheaper. Each plastic cup adds an additional cost but, if I buy all 50 cups all at once, the price per unit will be cheaper, reducing the cost further. Therefore, when I sell the fiftieth juice, the cost of that one will be much lower than the first one that was sold. That is because I allocated the total cost over fifty cups and not just one.
Let us suppose now that this cost for each additional unit sold increases continually, in other words, to sell one more unit, the price decreases in a much larger scale, it wouldn’t be necessary, if you consider that our juice is made, to buy more concentrate, water or sugar, because we only need to buy one more cup. This way, when we sell the thousandth juice, its cost would be so low that practically all of its price would be considered profit.
Like with our juice, let’s now mix Radical Innovation and the Economy of Scale.
Imagine that we are going to make something affordable, simple and accessible where there is a large Economy of Scale.
Disruptive innovation can transform companies into exponentials
Think of the following: imagine that I went to the United States, but I don’t speak English and I don’t know anything over there and I want to buy a car and drive around. If I grab my phone and buy a SIM card from a local service provider then put it in my phone and open the Waze app, would that solve my problem? Yes, of course.
What was the cost of the SIM card? With US$ 65.00 you can buy a SIM card in Brazil to use for 25 days in the United States. Therefore, you don’t even need to speak English in order to buy the SIM card. You just have to turn on your cell phone and start driving.
What cost did Waze incur in order for you to use the application in the United States? Practically none. The additional use of the app by somone else will not interfere with the costs of the company. In other words, it will be so low that it is almost insignificant. Waze is different from the earlier companies that produced GPSes. It won’t have to open a factory in the United States and contract personnel, erect buildings, build assembly lines, amongst other things, in order to grow. All Waze has to do is to encourage people to use its app, making it possible to grow exponentially in all places of the globe where there is an internet signal for cell phones, without the need to open even one office outside of its headquarters.
Waze follows precisely all the key elements of a disruptive innovation, in other words, it’s cheap, easy to use and accessible from anywhere. All these elements make Waze eligible to be a candidate for exponential growth, in case people realize that it is something useful.
So there we have the comparison between two types of companies, the traditional or linear one (GPS) and the one that can grow exponentially (Waze). Let’s go back to the juice. If we reach the fiftieth juice, I will have to once again buy the ingredients to make more juice so, it will be necessary to make additional investments for that to happen. This type of company is called Linear, in other words, it grows organically. Such are the traditional companies that produced GPSes. Waze, on the other hand, will not need to have a production line since it already uses existing resources, which are the cell phones that people have that were financed by themselves. Consequently, Waze does not need more factories, it only needs more users. Sourcing equipment in this way is infinitely cheaper and simpler than the production of GPSes in factories.
So we can therefore deduce that exponential organizations use disruptive innovations, being able to grow tens of times faster than their traditional competitors.
Let’s look at an example that can shed more light on this idea. In January of 2006 Nokia, a Finnish company, was one of the biggest producers of cell phones in the world. It was a respected and powerful company and it was valued at 140 billion dollars. In January of 2007, Apple launched the iPhone and had intentions of competing against the Finnish giant. However, the iPhone had something its competitors did not have. It had a virtual store which made it possible for small developers to come up with and offer their applications for this device. In March, Nokia purchased Navteq for 8.1 billion dollars. The company manufactured and installed sensors on roads allowing for the maps that were developed by Nokia to map transit and assess which routes were the fastest. In other words, it was a great innovation for the market, which could put into perspective the ambitious plans of the ‘apple’ and also that of Google with its Google Maps. The Navteq sensors were already installed in Europe, covering 400 thousand kilometers of roads over 35 big cities and 13 countries. This action was seen by various analysts of the time as innovative and inevitable for its growth expectations within the niche of companies in California.
At the same time, in Israel, Waze was created. An modest app that used people’s own cellphones as transit sensors. This way, it wouldn’t be necessary to install sensors on roads or to invest a fortune on equipment, factories, workers, offices, amongst other costs necessary to expand the network of mapped roads and cities. By being affordable, or actually free, the number of users matched the number of sensors from Navteq, and Waze did not have to spend even a penny for equipment that measured traffic. In four years, the number of Waze sensors, or its users, was ten times higher. Nokia was not able to keep up with Waze’s growth since it would have had to invest billions more in order to broaden its network of sensors. In 2012, because it was not able to grow, Nokia was then valued at 8,2 billion dollars, in other words, the same price that it had paid for Navteq. In 2013, Google purchased Waze for 1.1 billion dollars. The company had 100 employees and 50 million users.
Nokia was linear, it thought of growing with physical assets, factories, structures and people. Waze used what it already had, it was unpretentious in the way that it offered its app, simple and accessible in its usage and with zero cost to the consumer.
Exponential companies think differently, they think of growing without being capital-intensive by using what already exists and by facilitating the introduction into market. To be disruptive and exponential is to take advantage of what already exists. It is to be unpretentious, simple, useful and to look to innovate what really matters to people.