The Advantages of Adversity

November 15th, 2010 by Bhaskar Chakravorti

Difficult business environments can offer rich opportunities to entrepreneurs, so don’t let your next crisis go to waste.

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Jonathan Bush saw the opportunity to dramatically change how obstetrics practices function. He and his partner set out to build a medical business whose objective was to incorporate both traditional and holistic care options for mothers-to-be. Their aspirations were grand, and demand for their services rapidly grew. But when reliance on slow-paying insurers strapped the practice for cash, Bush’s vision got tangled in red tape.

In this failure, however, Bush envisioned what would ultimately become his truly innovative business idea: a health care IT service that spares its clients bureaucratic purgatory. That service, athenahealth, is now a $189 million business.

Unlike many managers whose instincts are to hunker down and play it safe during difficult times, entrepreneurs like Bush hear a call to action in the oft-repeated advice of Machiavelli: “Never waste the opportunities offered by a good crisis.” Even as the global economy lurches toward a new normal, long-term crises demand solutions in a variety of domains: geopolitics, the environment, health care, education, infrastructure, poverty and inequity juxtaposed with rapid growth, and broken business models in multiple industries. In fact, instead of the waves of expanding frontiers that defined the 20th century, constraint and restraint may define the 21st.

For entrepreneurs with an eye for counterintuitive solutions, extreme problems and seemingly insurmountable adversity can be a crucible for creativity and business-model innovation. In studying hundreds of companies that were created or reinvented in difficult circumstances of many stripes, I have identified four key types of opportunities that innovative entrepreneurs see and seize upon in a climate of extreme adversity. Those who face today’s tumultuous business environment can learn from their example. First, let’s learn about the business climate of adversity.

Adversity as a Context for Business

Considerable evidence shows that periods of extreme adversity foster innovation and the building of companies. For example, 18 of the 30 firms currently on the Dow Jones Industrial Index were founded during economic downturns. The Kauffman Index of Entrepreneurial Activity showed that the rate of new-business creation was higher during the deepest part of the 2009 recession than it had been in the 14 previous years, including the 1999–2000 technology boom.

Moments of crisis have historically served as a powerful impetus for innovation, whether a Manhattan Project, a moon shot, or industry-transforming “green” consciousness and its related initiatives. The entrepreneurs who thrive in the face of adversity are a different breed from those who flourish when resources are unlimited, such as in Silicon Valley during the 1990s.

What are the factors that distinguish entrepreneurs, corporate innovators, and investors who successfully harness adversity to gain competitive advantage? My research has shown that they tune in to the particular opportunities that characterize challenging times. Unmet need and high entry barriers clearly help to thin out the competitive field, but that’s also true for other entrepreneurial circumstances. I instead focus on the opportunities that are unique to situations of adversity and to success in such times. I label the opportunities according to how adversity-attuned entrepreneurs act on them—something they do quickly.

Opportunity 1: Match Unneeded Resources to Unmet Needs

Adversity comes in many forms—acute, cyclical, long-term, and systemic. It sometimes affects individuals or single firms; other times it cuts across a wide swath of entities. However, its pathology is consistent: Adversity constrains a key resource, which then depresses demand, supply, or both. That gives rise to unmet need and releases other resources that become redundant. An opportunity emerges for inventive entrepreneurs who can reroute the redundant resources to fill the unmet need.

Consider, again, Jonathan Bush. He was committed to having an impact in health care, but it didn’t happen right away. He drove an ambulance as an EMT, took a break from college to become an army medic after the launch of Operation Desert Storm, and eventually raised $1.6 million (with Todd Park, a former colleague from Booz Allen Hamilton) to buy a San Diego obstetrics practice in 1997.

The partners found that both government and private health insurers would take weeks or months to reimburse the practice, which had little negotiating power, for patients’ medical claims. Indeed, physician practices everywhere were struggling with outmoded forms of capturing and storing patient information on paper and Dictaphones. The industry structure and interlocking behaviors across the health care delivery chain had cemented a highly inefficient status quo.

Despite growing revenues, Bush was running out of cash and had to shut down the practice. But he and Park recognized an opportunity in a web-based service, called athenaNet, which they had developed to keep track of patients and their constantly changing insurance information. In 1999, they switched from being a clinical service to deploying athenaNet as a billing tool that would help physicians manage their revenue cycles more efficiently and track changes in insurance rules and provisions. The new company, athenahealth, became a pioneer in revenue-cycle management tools delivered over the internet. It subsequently used its web-based assets to deliver electronic health-records capabilities to its clients and, thereby, also address their need for information efficiency.

The company turned profitable after 2004, when revenues were $36 million, and went on to earn $189 million in 2009. Athenahealth’s physician base has grown 30% per year since 2005, with a 97% retention rate. It has the largest, most comprehensive, continually updated database on payer-reimbursement rules—the key drivers of claims payments and denials—in the United Sates. It also has consistently ranked number 1 or 2 in several key ambulatory and billing scheduling categories. Athenahealth stands alone in the field as the only internet-based provider of such services and was named among Fast Company’s 50 most innovative businesses for 2010.

Athenahealth ingeniously repurposed a resource made redundant by adverse circumstances to meet a basic need that the adversity had exposed. It’s a phenomenon that other sectors have witnessed as well. For example, once-redundant polysilicon has been repurposed by a host of solar energy entrepreneurs. And nascent IT companies in India redeployed plentiful, underutilized, highly trained programmers to respond to the Y2K crisis. Both of these experiences became foundations for the growth of major industries.

Opportunity 2: Round Up Unusual Suspects

Adversity is also characterized by missing or inadequate elements at critical points in the business system. These may include key inputs, capital, technologies, or partners in the supply, distribution, and marketing chains. Entrepreneurs who can creatively identify unlikely, alternative candidates are able to get a leg up. However, the art of aligning the incentives of an unorthodox coalition and maintaining equilibrium among the members is no small challenge.

Some people, such as investment banker Iqbal Quadir, manage to do it. He set out to pursue an outrageous vision: bringing universal telephone service to his native Bangladesh, which in 1993 had only one phone per 500 people. One of the world’s most resource- and infrastructure-poor countries, Bangladesh also had 80% of its population dispersed across 86,000 villages. Quadir was obviously facing gaps in the supply, distribution, and marketing chain sufficient to kill the best of business plans. How could he possibly implement wireless technology in a cost-efficient way and then market affordable service in this context?

Quadir’s real inspiration came when he realized that success would require enlisting the unlikeliest of allies. To benefit from economies of scale, he sought GSM (global system for mobile) digital-wireless technology as the cheapest long-term solution, even though it would be the most expensive at the outset. This took him across the world to Telenor, the Norwegian telecommunications company that is a global leader in GSM.

To scale up sufficiently, Quadir had to solve two additional problems. On the demand side, closing the marketing and distribution gaps meant turning to another unlikely ally, Grameen Bank, the microfinance pioneer that had a deep network among rural women in Bangladesh. Quadir saw an opportunity to repurpose the Grameen business model by encouraging the women to do business in telephones rather than cows and then use the money they made to pay back their microloans from the bank. On the supply side, Quadir had no assurance of interconnection facilities, which would be a barrier to Telenor’s attempt to stitch together a nationwide network. To overcome the obstacle, Quadir turned to a third unusual suspect: Bangladesh Railway. The dark fiber along its tracks could be activated to provide the interconnection.

Each player was motivated by the appeal of participating in a new growth opportunity that used existing capacity and technology. Without the simultaneous involvement of the others, however, each ally might have backed away. In effect, the unusual suspects’ interlocking incentives had been exquisitely aligned. By orchestrating a counterintuitive coalition, Quadir has made his venture, Grameenphone, the largest telephone provider in Bangladesh today. One in three Bangladeshis now has access to a phone.

Other entrepreneurs have taken different approaches to breaking from industry orthodoxy by seeking out unlikely partners. Take R.P. Eddy, whose clients needed on-the-ground research on hard-to-access markets, such as Iraq. Eddy did not have the capability to send analysts there, so instead he recruited a network of local in-country experts as open-source analysts. The consulting firm, Ergo, was thus born using a radically new model. Alternatively, others have turned to contests and prizes to harness the skills of previously unknown allies to address incredibly tough situations of adversity. According to a recent McKinsey study, the total value of all prizes worth $100,000 or more has grown 15-fold over the past 35 years. Before 1991, 98% of these prizes were for recognition; since then, 78% have been awarded for problem solving.

Opportunity 3: Find Small Solutions to Big Problems

The more severe the adversity, the harder it is to change the status quo. Comprehensive solutions that require many changes can appear to be dead on arrival, leaving only tiny cracks as points of entry to break the mold. The message for the intrepid entrepreneur: Small innovations can be huge. First, they are potentially more affordable and can be produced with less initial outlay. Second, they economize on features and complexity and may be just good enough to fulfill an unmet need. Third, their size can help minimize environmental effects or other negative externalities. Finally, they may be easier to integrate into the current model, with only minimal adjustments. In fact, four characteristics that, according to Trendwatching.com, define future consumer priorities may be the tiny cracks to look for: affordability, simplicity/convenience, sustainability, and design informed by local knowledge about product usage. Small solutions that fit within these tiny cracks represent major opportunities.

A case in point is Cameron Powell, an obstetrician in San Antonio, Texas, who faced a common problem in his field: potential liability related to failures in communication between the physician and the nursing staff at the expecting mother’s bedside. The structural obstacle was that obstetricians are usually on the move—from the office, to the ER, to various hospitals—making continuous bedside coverage cost-prohibitive.

When software engineer Trey Moore asked Powell to wish for his fantasy smartphone application, Powell realized that being able to see the baby’s heart tracing and the mother’s contractions anytime, anywhere would be a huge help to him and his staff. Powell and Moore figured that avoiding even a single lawsuit, with a median $2.5 million award, could make the investment worthwhile to a health care provider. Together they founded AirStrip Technologies, whose first product was a smartphone app called AirStrip OB. The app was easy to install on devices that physicians were already carrying, required very little behavioral change from users, and would be offered to hospitals on a software-as-a-service model, thereby minimizing their monetary commitment. In short, Powell had found a small solution to a very big problem.

AirStrip OB was celebrated by attendees at the Apple Worldwide Developers Conference in 2009, where only eight apps were chosen to be presented. Since then, more than 100 hospitals have adopted it. Among a highly select handful of inventions in wireless health care, it has been lauded by “rock star cardiologist” Eric Topol and David Pogue, technology columnist for the New York Times.

Small innovations such as AirStrip OB aim for major breakthroughs in contexts of extreme adversity. They are not designed simply to make incremental change and are proving to be part of a broad global trend. We now have, for example, cheap and space-efficient sachet packaging of consumer goods in developing markets; microfinance or software-as-a-service to fit limited business budgets; smartphone apps and Twitter for mobile consumers with fragmented attention capacity; and frugally engineered products (from vehicles to appliances to health care items) that ensure affordability and access in the fastest-growing markets, which still face much adversity.

Opportunity 4: Think Platform, Not Just Product

In general, the underlying factors that constrain one situation of adversity also constrain others. This offers an opportunity to invest in a meta-solution that can address several unmet needs simultaneously, either in multiple market segments or various product markets. The multifaceted character of the opportunity also hedges the entrepreneur’s risk and helps the venture grow beyond the initial point of entry. Clearly, entrepreneurs can expect varying levels of success, but the broader the venture’s reach is, the greater the value to be unlocked. The profit potential comes from the capacity to enhance the business model at three possible leverage points: customer value, cost management, and growth-vector creation.

Fred Khosravi and Amar Sawhney are an excellent example of a team who thought creatively about platform. Described by In Vivo as the “dynamic device development duo,” these biomedical entrepreneurs banded together to create Incept. They wanted the company to have no physical offices, only two or three employees, and an annual budget of less than $1 million. But Incept was a powerhouse. It held the rights to a “secret sauce” that would be responsible for nine start-ups in 11 years (none of them failed). Of the three spin-offs from these companies, the first, Confluent Surgical, was sold to Covidien for $245 million. The sauce was hydrogel, a harmless and highly versatile biodegradeable polymer.

Sawhney, the inventor of hydrogel technology, foresaw many applications, each solving a dilemma for physicians who performed complex or minimally invasive surgeries in medical specialties as varied as cardiology, gynecology, neurology, and ophthalmology. Current uses now include sealing organs and other parts of the anatomy (such as the lungs, brain, spinal cord, and blood vessels) that are at risk for leakage during surgery. Hydrogels can also be used to separate a damaged organ from an adjacent organ in order to avoid interference with healing.

The duo had clearly tapped into an opportunity with long-term potential for improving surgical procedures. Hydrogel technology was a true platform that could be applied to many parts of the human anatomy and, therefore, in multiple surgical “markets.” Ordinarily, venture capitalists and acquiring companies invest in a business whose core technologies are bundled with the products they sell in specific markets. Sawhney and Khosravi resisted convention, however, and focused on keeping the platform—and a stream of applications to address multiple problems—alive. They knew that bundling the hydrogel technology with its application could allow an acquiring company to own it, apply it only in a narrow market segment, and not use its full potential. Instead, they organized Incept so that it would own the patents on the hydrogel technology and license them to independent spin-off companies that Incept would incubate. It was a novel risk-management plan: an entire portfolio of application spin-offs targeting different markets but centered on a common core technology.

The notion of platforms need not be limited, though, to technologies and processes. Consider the case of the performance act Blue Man Group. As artists, they found the 1980s to be a particularly depressing decade. In New York City’s Central Park in 1988, they performed “Funeral for the ’80s,” during which they buried a Rambo doll and a piece of the Berlin Wall. For two decades since that unique debut, they have drummed, splashed paint, caught gumballs with their teeth, and smothered their audiences in toilet paper. The formula for the act was nothing short of a creative mission. Now that they are older and have children, the members of the group have turned their creative attention to another institution they find depressing: primary school education. They founded an alternative elementary school, called the Blue School, predicated on the same mission-driven platform as that of their original entertainment business: “to inspire creativity and connect people with their primal exuberance.”

A New Twist on Adverse Selection

To ground your thinking about the benefits that adversity can offer, go back to Michael E. Porter in The Competitive Advantage of Nations: “Competitive advantage emerges from pressure, challenge, and adversity, rarely from an easy life.” Necessity, coupled with four key opportunities, can indeed be the mother of some serious inventions.

During the 20th century, many breakthroughs took us to uncharted and unimagined territory. But now we are discovering their unintended consequences: unbalanced growth and self-limiting orthodoxies, which may well be the predominant features of the decades ahead. For example, the once-booming high-tech and auto industries are now in search of radically new business models to avoid obsolescence. Widespread discovery and use of nonrenewable resources are revealing their true environmental and geopolitical consequences. Health care innovations bred unsustainable cost structures, demographic imbalances, and limitations in pharmaceutical and health care delivery. Globalization has created myriad challenges of rapid growth in unevenly developed economies (such as Brazil, China, and India) and the potential that regional crises will spread throughout the world. And financial innovations led to uncontrolled speculative bubbles in some sectors. In the past few years alone, we have experienced some of the effects, including the Great Recession and its still-uncertain recovery, an unprecedented crisis with the euro, and the largest accidental oil spill in history. Clearly, the “new normal” is not short on adversity.

None of this will weaken entrepreneurship and innovation. The “new abnormals”—the entrepreneurs who survive—will be those who harness the competitive advantage of adversity. The present century holds a treasure trove of bottlenecks, constraints, and other major difficulties that will be with us for a long time. It would be a shame if—as entrepreneurs, managers, and investors—we were to let such an abundance of serious crises go to waste.

Bhaskar Chakravorti is a partner at McKinsey & Company and a distinguished scholar at MIT’s Legatum Center for Development and Entrepreneurship. He recently joined the faculty of Harvard Business School.