If you force me to choose, I pick the invention of quartz watch movements as one of the more astonishing examples of creative destruction in business. Once quartz arrived, the value propositions of most of the luxury Swiss watchmakers was instantly destroyed.

Pre-quartz, they competed on accuracy. But quartz watches were 10 times more accurate than the best of the hand-made Swiss watches. What was left? Not much. Many of the Swiss watchmakers went out of business, and that end of the watch industry has gone through an unbelievable amount of concentration – dominated now by Swatch, Richemont and LVMH.

If you do the math and check the sum against an economics text, that adds up to an oligopoly. Swatch has already used their market position to start to put the squeeze many of the remaining independent watchmakers – which puts enormous pressure on their already shaky business models. The powerful watchmakers appear to be switching to an extractive business model.

In their new book Why Nations Fail: The Origins of Power, Prosperity, and Poverty,Daron Acemoglu and James Robinson look at what distinguishes nations that successfully drive economic development from those that fail. William Easterly summarises their main points in a good review of the book:

Success comes, the authors say, when political and economic institutions are “inclusive” and pluralistic, creating incentives for everyone to invest in the future. Nations fail when institutions are “extractive,” protecting the political and economic power of only a small elite that takes income from everyone else.
…
Inclusive political institutions mean both a broad distribution of political power and limits to that power, such as democratic elections and written constitutions. Inclusive economic institutions encompass property rights, contract enforcement, ease of starting new companies, competitive markets, and freedom for citizens to enter the occupation and the industry of their choice. The billionaire telecommunications mogul Carlos Slim, we’re told, does not fall into this category. He is extractive, “a master at obtaining exclusive contracts,” winning economic monopolies through political connections, but he enriches primarily himself, not Mexico. Bill Gates, by contrast, enriches both himself and the U.S. because he can make money only by creating products that are better or more popular than those produced by rivals.

Just as inclusive institutions feed on each other, so do their opposites: Extractive political institutions support the economic institutions that protect the interests of the elite against new entry from competitors. The wealth of the elite so created can make the hierarchical, authoritarian state even larger and more repressive, increasing elite wealth even more. This vicious cycle means that bad history persists into bad present outcomes.

Compare that story to what is happening in watches, and Richemont and company don’t look very inclusive. In fact, extractive business models are one of the hallmarks of monopolies and oligopolies. Furthermore, by their very nature, extractive business models kill innovation. Lack of innovation causes big problems over the long term – both for countries, as Acemoglu and Robinson show, and for firms.

If you don’t innovate, what’s left? Extraction. In watches, this has now extended beyond independent watchmakers to independent watch repairers. Here’s a video that shows what is happening:

Nicholas Hacko, a watchmaker in Sydney, explains how this extractive behaviour is leading the Swiss watchmakers to miss the next wave of disruption in the industry. First, he describes some of the coming innovations in smart watches, then:

…here is my key point: the battle is not about the technology, or price, or even performance, this battle is all about that precious “piece of real-estate” – your wrist!

The smart technology is no longer happy to place your gadget in your bag, or back pocket. The smart watch wants to be placed on one and only one spot it deserves – YOUR WRIST. This is what the battle is all about.

You may have a bunch of watches, but you can wear only one at the time.

And you need not be clairvoyant to figure out which one will take that well deserved spot: a smart one, which represents free spirit, creativity, ever changing design, a watch which talks to you, and represents the new age of NO RESTRICTION; or the other one, which is a product of Swiss monopoly whose main concern is how to stop everyone else from entering the market (including fellow Swiss makers), restrictive to the extreme and arrogantly treat the most loyal supporters as ignorant, and whose only business model is this: “if it does not sell, double the price.” A watch made by a company which refuses to sell you a spare part, spare bracelet, even a spare link! A maker so arrogant who can afford to upset even the most loyal customers and brand promoters.

Quartz watches were a classic disruptive innovation. The incumbents were either unwilling or unable to respond to the new technology. Now it is happening again. Why is Sony driving this new technology rather than Swatch? Why would you miss out on something like this?

I don’t know. The same mistakes are repeated – this is what makes studying innovation both fascinating and frustrating.

Extractive business models fail for several reasons. They destroy the ecosystems that support them, they stop innovating, and then they are ambushed by a disruptive innovation. Fortunately, this happens a bit more easily in markets than in nations.

Make way for the innovators.

Note: Many independent watch repairers are trying to fight the cut-off of supply. You can find out more about this at www.save-the-time.org. I signed their petition, so you can see where my sympathies lie.