Attacked From Below

by breeve 1. May 2010 15:02

Few companies could compete with Bucyrus Erie in the early half of the twentieth century. Their cable pulley excavators powered by gas engines—capable of holding up to 5 cubic yards in their massive steal jaws—where vital to the mining, canal digging, sewer and piping industries. Ironically, their biggest competition threat would not come from other ambitions pulley excavators but from a little company called Sherman which was pushing a small hydraulic shovel that moved a puny ¼ cubic yards and attached to a farm tracker. They named it the backhoe.

The backhoe began innocently enough with the invention of hydraulic technology in the late 1940’s. Lacking the earth moving capacity and distribution of Bucyrus, companies like Sherman designed their backhoes to be compatible with popular farm tractors of the day like John Deere. Unexpectedly, the backhoes found a devoted following with residential contractors who appreciated their maneuverability allowing them to squeeze between houses to dig water and sewage lines. Without the machines, the trenches had to be dug by hand which made even the most devoted ditch digger want to beat themselves senseless with their own shovel.

If Bucyrus was afraid of the hydraulic threat, it didn’t show it. Bucyrus viewed the cute backhoes as too wimpy for their customers needs. Their customers, after all, were demanding bigger bucket sizes that hydraulics couldn’t match so Bucyrus continued investing in cable technology to meet existing customer needs.

And while Bucyrus was putting their best engineers minds to work squeezing more tension out of those steal cables, other smaller companies like Caterpillar took notice. With Caterpillar and others pushing hydraulics they improved at an astonishing rate. In 1955 bucket size was 3/8 cubic yards, ½ cubic yards by 1960, and 2 cubic yards by 1965. Only 9 years later in 1974 bucket size reached 10 cubic yards and continued to climb skyward. It was as if Caterpillar showed up one day in front of Bucyrus headquarters with a 10 cubic yard hydraulic machine and offered to dig their sewage lines.

In reality, Bucyrus knew all about hydraulics they just didn’t care. Only after hydraulics capacity reached 2 cubic yards did things began to go south. At that size, sewer and pipe contractors became interested for the first time and with sewer and pipe contractors representing a good chunk of their business they began to lose revenue. Even worse, at 5 cubic yards hydraulics started to dig into their prime business of general excavators. How did this happen?

To outside observers the Bucyrus dilemma seems easily preventable. For starters, they could have invested in hydraulics technology earlier allowing them to build up their expertise. With this expertise they would be better able to compete in the new hydraulic market when hydraulics reached sizes their customers cared about.

This criticism is justified but the answers are not clear cut. When hydraulics first came out their usefulness was unclear. At ¼ cubic yards their functionality was limited to small markets. After years of doing business, Bucyrus had built up a cost structure that needed certain revenues to sustain. The hydraulic market initially was not big enough to justify significant investment from them. The revenue generated would be small at best when compared to their cost structure so Bucyrus felt their resources would be better spent improving their existing products. After all, no one knew if hydraulics would continue to improve.

The uncertainly around how disruptive technology will improve and whether established businesses should invest is a hard decision to make. In the book Innovator’s Dilemma, Clayton Christensen describes the struggles business leaders face when confronting disruptive technology like Bucyrus faced with hydraulics. In one part, Clayton describes that during the 80’s established computer disk drive companies where being attacked by disruptive upstarts sporting sexy smaller drives. One of those established companies, Seagate, was struggling in 1985 with whether to make 3.5-inch drives when they were already the leader in 5.25-inch drives.

Seagate was confronted with this decision when overly ambitious engineers developed working 3.5-inch prototype drives. Seagate marketing showed the drives to IBM PC division even though the capacity was clearly lacking compared to the existing 5.25-inch drives. IBM was not interested as their computers were designed for 5.25-inch drives and they were looking for greater capacity not less. As a former Seagate manager put it: “We needed a new model which could become the next ST412—a very successful product generating $300 million sales annually in the desktop market that was near the end of its life cycle. Our forecasts for the 3.5-inch drives were under $50 million because the laptop market was just emerging, and the 3.5-inch product just didn’t fit the bill.”

Seagate scrapped the 3.5-inch drive and paid dearly for it later as the drives got more popular. But here lies the crux of the dilemma. As firms get bigger their cost structures get bigger thus making it harder to innovate. Disruptive technologies have uncertain markets with low margins which established firms don’t like because they are liable to their share holders to grow and make more money. It is hard to justify dabbling in low margin uncertain markets when existing products with known markets and large margins can be improved.

So ironically, as companies get bigger they become more vulnerable to being attacked from below by small innovative firms. Lower cost structures allow startups to experiment with new technology. This is why innovation typically comes from small firms. If the technology improves, it finds new markets and can—as we saw with Bucyrus—began to steal away customers from established firms. If enough customers are stolen, the established firm will go out of business. This often happens and why we see large companies fail.

Even today, a glance at Bucyrus website reveals it still hasn’t penetrated the hydraulic market. Caterpillar has that covered.

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I am a Principal Engineer with 13 years experience developing and releasing software products. I started developing in C/C++ then moved into .NET and C# and have tech lead multiple projects. I have developed products in Windows Forms, ASP.NET/MVC, Silverlight, and WPF. I currently reside in Austin, Texas.

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