Creative Destruction: The Way Economics Handles Innovation

Creative destruction is an economics concept whereby new innovations make older innovations obsolete. Companies that revolutionize and dominate industries—Xerox in copiers, Polaroid in instant photography—see their downfall as rivals launch improved designs or cut manufacturing costs. Take the cassette tape. It replaced the 8-track, only to be overruled by the compact disc, which was then trumped by downloadable music in MP3 players, which were then rendered obsolete by today’s web-based streaming platforms. Another example is how news sites like the Huffington Post are destroying traditional newspapers.

Innovation is a source of temporary market power. It lowers the profit and positioning of established firms, and ultimately loses out to the innovations of new entrants. So the cycle goes. One economist, Ludwig Lachmann, put it thus, “The owners of wealth, are like the guests at a hotel or passengers in a train: They are always there but are never for long the same people.” Innovation continuously destroys olden industries and ways of doing things, while simultaneously creating new opportunities, markets, and industries. This is how the economy evolves.

The core idea is new tech or business models emerge and render old ones obsolete. Digital photography disrupted the film industry. Streaming services changed how we view and consume media as a whole. Even if the new technology starts off slow, small, and unpolished, it can eventually overtake established players by offering value or efficiency. Economic processes are driven by a cycle of renewal: the old method is phased out, the new takes its place. For instance, in manufacturing, robotics and automation have replaced manual assembly lines by now, resulting in higher productivity and new job positions. The cycle isn’t about failing or winning: it’s about transforming and evolving as a species.

While creative destruction seems all-things beneficial—innovation, growth, disruption—it also ripples down the economy. People lose their jobs. Businesses die out. Short-term economic pain looms large. Take the case of e-commerce: it revolutionized retail, but many brick-and-mortar stores have suffocated and closed as a result. The process forces societies and individuals to evolve continuously. Staying in place means being left behind. Entrepreneurs and companies alike thus have to embrace creative disruption and challenge the status quo. And they do. Think Uber in transport or Airbnb in accommodation.

Encouraging innovation means understanding that some ventures will be complete slips. That’s okay. These failures pave the way for breakthroughs. The author of the concept, Schumpeter, saw it as an essential for long-term economic sustainability. Dismantling outdated and reassembling novel economies drives growth. The smartphone revolution redefined communication, computing, and photography, leaving behind landlines and standalone cameras. Print newspapers have been supplanted by digital news platforms. The shift from fossil fuels to renewable energy sources—wind, solar—is reshaping the energy landscape. We create new. We destroy old. We progress. View it as a long-term investment. Better products, services, and efficiency in the future, for a temporary dose of job losses and business failures.

How to employ it as a mental model: (1) embrace change, understanding creative destruction as a natural part of the process—rather than resisting new stuff, look for the opportunities formed by it; (2) invest in innovation, such as by allocating resources to explore new technologies and ideas even if they threaten the existing norm—companies have dedicated research and brainstorming labs for a reason; (3) plan for transition, anticipating that change is inevitable and preparing for it by forming contingency plans, such as training employees to help them transition to evolving roles; (4) use the setbacks and temporary inefficiencies as learning opportunities, asking what the failure or inability to adapt quickly enough taught you about your company and/or industry; (5) stay adaptive, encouraging open-mindedness and trying new things in yourself and your subordinates.

Creative destruction is the engine of economic evolution. It’s a useful mental model for evaluating how progress comes at the cost of doing things the old way. Embrace it. Let go of the outdated for the updated. Harness the transformative power of innovation. Where have you stuck to your guns for too long? Find that area. It might be a leverage point for big increases in efficiency. In a dynamic world, change is the only constant. Every ending paves the way for a new beginning. Creating destroys.