Blue Ocean Strategy (2005) PDF

TLFeBOOK Blue Ocean Strategy Blue Ocean Strategy ) ) ) ) ( ( ( ( ( How to Create Uncontested Market Space and Make the Competition Irrelevant W. Chan Kim Renée...

TLFeBOOK Blue Ocean Strategy Blue Ocean Strategy ) ) ) ) ( ( ( ( ( How to Create Uncontested Market Space and Make the Competition Irrelevant W. Chan Kim Renée Mauborgne H A R VA R D B U S I N E S S S C H O O L P R E S S BOSTON, MASSACHUSETTS Copyright 2005 Harvard Business School Publishing Corporation All rights reserved Printed in the United States of America 09 08 07 06 05 5 4 3 2 1 No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise), without the prior permission of the publisher. Requests for permission should be directed to [email protected], or mailed to Permissions, Harvard Business School Publishing, 60 Harvard Way, Boston, Massachusetts 02163. Library of Congress Cataloging-in-Publication Data Kim, W. Chan. Blue ocean strategy: how to create uncontested market space and make the competition irrelevant / W. Chan Kim, Renée Mauborgne. p. cm. Includes bibliographical references and index. ISBN 1-59139-619-0 (hardcover: alk. paper) 1. New products. 2. Market segmentation. I. Mauborgne, Renée. II. Title. HF5415.153.K53 2005 658.8
02—dc22 2004020857 The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Publications and Documents in Libraries and Archives Z39.48–1992 To friendship and to our families, who make our worlds more meaningful  ) ) ) ) ( ( ( ( Contents Preface ix Acknowledgments xiii Part One: Blue Ocean Strategy 1 Creating Blue Oceans 3 2 Analytical Tools and Frameworks 23 Part Two: Formulating Blue Ocean Strategy 3 Reconstruct Market Boundaries 47 4 Focus on the Big Picture, Not the Numbers 81 5 Reach Beyond Existing Demand 101 6 Get the Strategic Sequence Right 117 viii Contents Part Three: Executing Blue Ocean Strategy 7 Overcome Key Organizational Hurdles 147 8 Build Execution into Strategy 171 9 Conclusion: The Sustainability and Renewal of Blue Ocean Strategy 185 Appendix A 191 Appendix B 209 Appendix C 213 Notes 217 Bibliography 223 Index 231 About the Authors 239  ) ) ) ) ( ( ( ( Preface T HIS IS A BOOK about friendship, about loyalty, about believing in one another. It was because of that friend- ship, and that belief, that we set out on the journey to explore the ideas in this book and eventually came to write it. We met twenty years ago in a classroom—one the professor, the other the student. And we have worked together ever since, often seeing ourselves along the journey as two wet rats in a drain. This book is not the victory of an idea but of a friendship that we have found more meaningful than any idea in the world of business. It has made our lives rich and our worlds more beautiful. We were not alone. No journey is easy; no friendship is filled only with laughter. But we were excited every day of that journey because we were on a mis- sion to learn and improve. We believe passionately in the ideas in this book. These ideas are not for those whose ambition in life is to get by or merely to survive. That was never an interest of ours. If you can be satisfied with that, do not read on. But if you want to make a difference, to create a company that builds a future where customers, employees, shareholders, and society win, read on. We are not saying it is easy, but it is worthwhile. x Preface Our research confirms that there are no permanently excellent companies, just as there are no permanently excellent industries. As we have found on our own tumbling road, we all, like corpora- tions, do smart things and less-than-smart things. To improve the quality of our success we need to study what we did that made a positive difference and understand how to replicate it systemati- cally. That is what we call making smart strategic moves, and we have found that the strategic move that matters centrally is to cre- ate blue oceans. Blue ocean strategy challenges companies to break out of the red ocean of bloody competition by creating uncontested market space that makes the competition irrelevant. Instead of dividing up exist- ing—and often shrinking—demand and benchmarking competi- tors, blue ocean strategy is about growing demand and breaking away from the competition. This book not only challenges compa- nies but also shows them how to achieve this. We first introduce a set of analytical tools and frameworks that show you how to sys- tematically act on this challenge, and, second, we elaborate the principles that define and separate blue ocean strategy from compe- tition-based strategic thought. Our aim is to make the formulation and execution of blue ocean strategy as systematic and actionable as competing in the red wa- ters of known market space. Only then can companies step up to the challenge of creating blue oceans in a smart and responsible way that is both opportunity maximizing and risk minimizing. No company—large or small, incumbent or new entrant—can afford to be a riverboat gambler. And no company should. The contents of this book are based on more than fifteen years of research, data stretching back more than a hundred years, and a se- ries of Harvard Business Review articles as well as academic arti- cles on various dimensions of this topic. The ideas, tools, and frameworks presented here have been further tested and refined over the years in corporate practice in Europe, the United States, and Asia. This book builds on and extends this work by providing a narrative arc that draws these ideas together to offer a unified  Preface xi framework. This framework addresses not only the analytic as- pects behind the creation of blue ocean strategy but also the all- important human aspects of how to bring an organization and its people on this journey with a willingness to execute these ideas in action. Here, understanding how to build trust and commitment, as well as an understanding of the importance of intellectual and emotional recognition, are highlighted and brought to the core of strategy. Blue ocean opportunities have been out there. As they have been explored, the market universe has been expanding. This expansion, we believe, is the root of growth. Yet poor understanding exists both in theory and in practice as to how to systematically create and capture blue oceans. We invite you to read this book to learn how you can be a driver of this expansion in the future.  ) ) ) ) ( ( ( ( Acknowledgments W in actualizing E H AV E H A D S I G N I F I C A N T H E L P this book. INSEAD has provided a unique environ- ment in which to conduct our research. We have benefited greatly from the crossover between theory and practice that exists at INSEAD, and from the truly global composition of our faculty, stu- dent, and executive education populations. Deans Antonio Borges, Gabriel Hawawini, and Ludo Van der Heyden provided encourage- ment and institutional support from the start and allowed us to closely intertwine our research and teaching. Pricewaterhouse- Coopers (PwC) and the Boston Consulting Group (BCG) have ex- tended the financial support for our research; in particular, Frank Brown and Richard Baird at PwC, and René Abate, John Clarkeson, George Stalk, and Olivier Tardy of BCG have been valued partners. While we had help from a highly talented group of researchers over the years, our two dedicated research associates, Jason Hunter and Ji Mi, who have worked with us for the last several years, deserve special mention. Their commitment, persistent re- search support, and drive for perfection, were essential in realizing this book. We feel blessed by their presence. xiv Acknowledgments Our colleagues at the school have contributed to the ideas in the book. INSEAD faculty members, particularly Subramanian Ran- gan and Ludo Van der Heyden, helped us to reflect upon our ideas and offered valuable comments and support. Many of INSEAD’s faculty have taught the ideas and frameworks in this book to execu- tive and M.B.A. audiences, providing valuable feedback that sharp- ened our thinking. Others have provided intellectual encourage- ment and the energy of kindness. We thank here, among others, Ron Adner, Jean-Louis Barsoux, Ben Bensaou, Henri-Claude de Bettignies, Mike Brimm, Laurence Capron, Marco Ceccagnoli, Karel Cool, Arnoud De Meyer, Ingemar Dierickx, Gareth Dyas, George Eapen, Paul Evans, Charlie Galunic, Annabelle Gawer, Javier Gimeno, Dominique Héau, Neil Jones, Philippe Lasserre, Jean-François Manzoni, Jens Meyer, Claude Michaud, Deigan Morris, Quy Nguyen-Huy, Subramanian Rangan, Jonathan Story, Heinz Thanheiser, Ludo Van der Heyden, David Young, Peter Zem- sky, and Ming Zeng. We have been fortunate to have a network of practitioners and case writers across the globe. They have contributed greatly in showing how the ideas in this book apply in action and helping to develop case material for our research. Among many people, one deserves special mention: Marc Beauvois-Coladon, who has worked with us from the start and made a major contribution to chapter 4 based on his field experiences practicing our ideas in companies. Among the wealth of others, we would like to thank Francis Gouillart and his associates; Gavin Fraser and his associates; Wayne Morten- sen; Brian Marks; Kenneth Lau; Yasushi Shiina; Jonathan Landrey and his associates; Junan Jiang; Ralph Trombetta and his associ- ates; Gabor Burt and his associates; Shantaram Venkatesh; Miki Kawawa and her associates; Atul Sinha and his associates; Arnold Izsak and his associates; Volker Westermann and his associates; Matt Williamson; and Caroline Edwards and her associates. We also appreciate the emerging cooperation with Accenture as kicked off with Mark Spelman, Omar Abbosh, Jim Sayles, and their team. Thanks are also due to Lucent Technologies for their support.  Acknowledgments xv During the course of our research, we have met with corporate executives and public officers around the world who generously gave us their time and insight, greatly shaping the ideas in this book. We are grateful to them. Among many private and public ini- tiatives for putting our ideas into practice, the Value Innovation Program (VIP) Center at Samsung Electronics and the Value Inno- vation Action Tank (VIAT) in Singapore for the country’s govern- ment and private sectors have been major sources of inspiration and learning. In particular, Jong-Yong Yun at Samsung Electronics and all the Permanent Secretaries of Singapore Government have been valued partners. Warm thanks also to the members of the Value Innovation Network (VIN), a global community of practice on the Value Innovation family of concepts—especially to those we were unable to mention here. Finally, we would like to thank Melinda Merino, our editor, for her wise comments and editorial feedback, and the Harvard Busi- ness School Publishing team for their commitment and enthusias- tic support. Thanks also to our present and past editors at Harvard Business Review, in particular David Champion, Tom Stewart, Nan Stone, and Joan Magretta. We owe a great deal to INSEAD M.B.A.’s and Ph.D.’s and executive education participants. Particu- larly, participants in both Strategy and Value Innovation Study Group (VISG) courses have been patient as we have tried out the ideas in this book. Their challenging questions and thoughtful feedback clarified and strengthened our ideas.  PA RT O N E ) ) ) ) ( ( ( ( ( Blue Ocean Strategy CHAPTER 1 ) ) ) ) ( ( ( ( Creating Blue Oceans A ONE TIME ACCORDION PLAYER, stilt-walker, and fire- eater, Guy Laliberté is now CEO of Cirque du Soleil, one of Canada’s largest cultural exports. Created in 1984 by a group of street performers, Cirque’s productions have been seen by almost forty million people in ninety cities around the world. In less than twenty years Cirque du Soleil has achieved a level of revenues that took Ringling Bros. and Barnum & Bailey—the global champion of the circus industry—more than one hundred years to attain. What makes this rapid growth all the more remarkable is that it was not achieved in an attractive industry but rather in a declining industry in which traditional strategic analysis pointed to limited potential for growth. Supplier power on the part of star performers was strong. So was buyer power. Alternative forms of entertain- ment—ranging from various kinds of urban live entertainment to sporting events to home entertainment—cast an increasingly long shadow. Children cried out for PlayStations rather than a visit to the traveling circus. Partially as a result, the industry was suffer- ing from steadily decreasing audiences and, in turn, declining rev- enue and profits. There was also increasing sentiment against the 4 B LU E O C E A N S T R AT E G Y use of animals in circuses by animal rights groups. Ringling Bros. and Barnum & Bailey set the standard, and competing smaller cir- cuses essentially followed with scaled-down versions. From the per- spective of competition-based strategy, then, the circus industry appeared unattractive. Another compelling aspect of Cirque du Soleil’s success is that it did not win by taking customers from the already shrinking circus industry, which historically catered to children. Cirque du Soleil did not compete with Ringling Bros. and Barnum & Bailey. Instead it created uncontested new market space that made the competi- tion irrelevant. It appealed to a whole new group of customers: adults and corporate clients prepared to pay a price several times as great as traditional circuses for an unprecedented entertain- ment experience. Significantly, one of the first Cirque productions was titled “We Reinvent the Circus.” New Market Space Cirque du Soleil succeeded because it realized that to win in the fu- ture, companies must stop competing with each other. The only way to beat the competition is to stop trying to beat the competition. To understand what Cirque du Soleil has achieved, imagine a market universe composed of two sorts of oceans: red oceans and blue oceans. Red oceans represent all the industries in existence today. This is the known market space. Blue oceans denote all the industries not in existence today. This is the unknown market space. In the red oceans, industry boundaries are defined and accepted, and the competitive rules of the game are known.1 Here, companies try to outperform their rivals to grab a greater share of existing de- mand. As the market space gets crowded, prospects for profits and growth are reduced. Products become commodities, and cutthroat competition turns the red ocean bloody. Blue oceans, in contrast, are defined by untapped market space, demand creation, and the opportunity for highly profitable growth.  Creating Blue Oceans 5 Although some blue oceans are created well beyond existing indus- try boundaries, most are created from within red oceans by expand- ing existing industry boundaries, as Cirque du Soleil did. In blue oceans, competition is irrelevant because the rules of the game are waiting to be set. It will always be important to swim successfully in the red ocean by outcompeting rivals. Red oceans will always matter and will al- ways be a fact of business life. But with supply exceeding demand in more industries, competing for a share of contracting markets, while necessary, will not be sufficient to sustain high performance.2 Companies need to go beyond competing. To seize new profit and growth opportunities, they also need to create blue oceans. Unfortunately, blue oceans are largely uncharted. The dominant focus of strategy work over the past twenty-five years has been on competition-based red ocean strategies.3 The result has been a fairly good understanding of how to compete skillfully in red waters, from analyzing the underlying economic structure of an existing industry, to choosing a strategic position of low cost or differentia- tion or focus, to benchmarking the competition. Some discussions around blue oceans exist.4 However, there is little practical guid- ance on how to create them. Without analytic frameworks to create blue oceans and principles to effectively manage risk, creating blue oceans has remained wishful thinking that is seen as too risky for managers to pursue as strategy. This book provides practical frameworks and analytics for the systematic pursuit and capture of blue oceans. The Continuing Creation of Blue Oceans Although the term blue oceans is new, their existence is not. They are a feature of business life, past and present. Look back one hun- dred years and ask yourself, How many of today’s industries were then unknown? The answer: Many industries as basic as automo- biles, music recording, aviation, petrochemicals, health care, and 6 B LU E O C E A N S T R AT E G Y management consulting were unheard of or had just begun to emerge at that time. Now turn the clock back only thirty years. Again, a plethora of multibillion-dollar industries jumps out—mu- tual funds, cell phones, gas-fired electricity plants, biotechnology, discount retail, express package delivery, minivans, snowboards, coffee bars, and home videos, to name a few. Just three decades ago, none of these industries existed in a meaningful way. Now put the clock forward twenty years—or perhaps fifty years— and ask yourself how many now unknown industries will likely exist then. If history is any predictor of the future, again the answer is many of them. The reality is that industries never stand still. They continu- ously evolve. Operations improve, markets expand, and players come and go. History teaches us that we have a hugely underesti- mated capacity to create new industries and re-create existing ones. In fact, the half-century-old Standard Industrial Classifica- tion (SIC) system published by the U.S. Census was replaced in 1997 by the North America Industry Classification Standard (NAICS) system. The new system expanded the ten SIC industry sectors into twenty sectors to reflect the emerging realities of new industry ter- ritories.5 The services sector under the old system, for example, is now expanded into seven business sectors ranging from informa- tion to health care and social assistance.6 Given that these systems are designed for standardization and continuity, such a replace- ment shows how significant the expansion of blue oceans has been. Yet the overriding focus of strategic thinking has been on com- petition-based red ocean strategies. Part of the explanation for this is that corporate strategy is heavily influenced by its roots in mili- tary strategy. The very language of strategy is deeply imbued with military references—chief executive “officers” in “headquarters,” “troops” on the “front lines.” Described this way, strategy is about confronting an opponent and fighting over a given piece of land that is both limited and constant.7 Unlike war, however, the his- tory of industry shows us that the market universe has never been constant; rather, blue oceans have continuously been created over  Creating Blue Oceans 7 time. To focus on the red ocean is therefore to accept the key constraining factors of war—limited terrain and the need to beat an enemy to succeed—and to deny the distinctive strength of the business world: the capacity to create new market space that is un- contested. The Impact of Creating Blue Oceans We set out to quantify the impact of creating blue oceans on a com- pany’s growth in both revenues and profits in a study of the busi- ness launches of 108 companies (see figure 1-1). We found that 86 percent of the launches were line extensions, that is, incremental improvements within the red ocean of existing market space. Yet they accounted for only 62 percent of total revenues and a mere 39 percent of total profits. The remaining 14 percent of the launches were aimed at creating blue oceans. They generated 38 percent of total revenues and 61 percent of total profits. Given that business launches included the total investments made for creating red and blue oceans (regardless of their subsequent revenue and profit con- sequences, including failures), the performance benefits of creating F I G U R E 1-1 The Profit and Growth Consequences of Creating Blue Oceans Business Launch 86% 14% Revenue Impact 62% 38% Profit Impact 39% 61% Launches within red oceans Launches for creating blue oceans 8 B LU E O C E A N S T R AT E G Y blue waters are evident. Although we don’t have data on the hit rate of success of red and blue ocean initiatives, the global performance differences between them are marked. The Rising Imperative of Creating Blue Oceans There are several driving forces behind a rising imperative to create blue oceans. Accelerated technological advances have substantially improved industrial productivity and have allowed suppliers to pro- duce an unprecedented array of products and services. The result is that in increasing numbers of industries, supply exceeds de- mand.8 The trend toward globalization compounds the situation. As trade barriers between nations and regions are dismantled and as information on products and prices becomes instantly and glob- ally available, niche markets and havens for monopoly continue to disappear.9 While supply is on the rise as global competition inten- sifies, there is no clear evidence of an increase in demand world- wide, and statistics even point to declining populations in many developed markets.10 The result has been accelerated commoditization of products and services, increasing price wars, and shrinking profit margins. Recent industrywide studies on major American brands confirm this trend.11 They reveal that for major product and service cate- gories, brands are generally becoming more similar, and as they are becoming more similar people increasingly select based on price.12 People no longer insist, as in the past, that their laundry detergent be Tide. Nor will they necessarily stick to Colgate when Crest is on sale, and vice versa. In overcrowded industries, differentiating brands becomes harder in both economic upturns and downturns. All this suggests that the business environment in which most strategy and management approaches of the twentieth century evolved is increasingly disappearing. As red oceans become increas- ingly bloody, management will need to be more concerned with blue oceans than the current cohort of managers is accustomed to.  Creating Blue Oceans 9 From Company and Industry to Strategic Move How can a company break out of the red ocean of bloody competi- tion? How can it create a blue ocean? Is there a systematic ap- proach to achieve this and thereby sustain high performance? In search of an answer, our initial step was to define the basic unit of analysis for our research. To understand the roots of high performance, the business literature typically uses the company as the basic unit of analysis. People have marveled at how companies attain strong, profitable growth with a distinguished set of strate- gic, operational, and organizational characteristics. Our question, however, was this: Are there lasting “excellent” or “visionary” companies that continuously outperform the market and repeat- edly create blue oceans? Consider, for example, In Search of Excellence and Built to Last.13 The bestselling book In Search of Excellence was published twenty years ago. Yet within two years of its publication a number of the companies surveyed began to slip into oblivion: Atari, Chesebrough- Pond’s, Data General, Fluor, National Semiconductor. As docu- mented in Managing on the Edge, two-thirds of the identified model firms in the book had fallen from their perches as industry leaders within five years of its publication.14 The book Built to Last continued in the same footsteps. It sought out the “successful habits of visionary companies” that had a long- running track record of superior performance. To avoid the pitfalls of In Search of Excellence, however, the survey period of Built to Last was expanded to the entire life span of the companies while its analysis was limited to firms more than forty years old. Built to Last also became a bestseller. But again, upon closer examination, deficiencies in some of the visionary companies spotlighted in Built to Last have come to light. As illustrated in the recent book Creative Destruction, much of the success attributed to some of the model companies in Built to Last was the result of industry sector performance rather than the 10 B LU E O C E A N S T R AT E G Y companies themselves.15 For example, Hewlett-Packard (HP) met the criteria of Built to Last by outperforming the market over the long term. In reality, while HP outperformed the market, so did the entire computer-hardware industry. What’s more, HP did not even outperform the competition within the industry. Through this and other examples, Creative Destruction questioned whether “visionary” companies that continuously outperform the market have ever ex- isted. And we all have seen the stagnating or declining performance of the Japanese companies that were celebrated as “revolutionary” strategists in their heyday of the late 1970s and early 1980s. If there is no perpetually high-performing company and if the same company can be brilliant at one moment and wrongheaded at another, it appears that the company is not the appropriate unit of analysis in exploring the roots of high performance and blue oceans. As discussed earlier, history also shows that industries are con- stantly being created and expanded over time and that industry conditions and boundaries are not given; individual actors can shape them. Companies need not compete head-on in a given indus- try space; Cirque du Soleil created a new market space in the enter- tainment sector, generating strong, profitable growth as a result. It appears, then, that neither the company nor the industry is the best unit of analysis in studying the roots of profitable growth. Consistent with this observation, our study shows that the strategic move, and not the company or the industry, is the right unit of analysis for explaining the creation of blue oceans and sus- tained high performance. A strategic move is the set of managerial actions and decisions involved in making a major market-creating business offering. Compaq, for example, was acquired by Hewlett- Packard in 2001 and ceased to be an independent company. As a re- sult, many people might judge the company as unsuccessful. This does not, however, invalidate the blue ocean strategic moves that Compaq made in creating the server industry. These strategic moves not only were a part of the company’s powerful comeback in the mid-1990s but also unlocked a new multibillion-dollar market space in computing.  Creating Blue Oceans 11 Appendix A, “A Sketch of the Historical Pattern of Blue Ocean Creation,” provides a snapshot overview of the history of three rep- resentative U.S. industries drawn from our database: the auto in- dustry—how we get to work; the computer industry—what we use at work; and the cinema industry—where we go after work for en- joyment. As shown in appendix A, no perpetually excellent com- pany or industry is found. But a striking commonality appears to exist across strategic moves that have created blue oceans and have led to new trajectories of strong, profitable growth. The strategic moves we discuss—moves that have delivered prod- ucts and services that opened and captured new market space, with a significant leap in demand—contain great stories of profitable growth as well as thought-provoking tales of missed opportunities by companies stuck in red oceans. We built our study around these strategic moves to understand the pattern by which blue oceans are created and high performance achieved. We studied more than one hundred fifty strategic moves made from 1880 to 2000 in more than thirty industries, and we closely examined the relevant business players in each of these events. Industries ranged from hotels, the cinema, retail, airlines, energy, computers, broadcasting, and con- struction to automobiles and steel. We analyzed not only winning business players who created blue oceans but also their less suc- cessful competitors. Both within a given strategic move and across strategic moves, we searched for convergence among the group that created blue oceans and within less successful players caught in the red ocean. We also searched for divergence across these two groups. In so doing, we tried to discover the common factors leading to the cre- ation of blue oceans and the key differences separating those win- ners from the mere survivors and the losers adrift in the red ocean. Our analysis of more than thirty industries confirms that neither industry nor organizational characteristics explain the distinction between the two groups. In assessing industry, organizational, and strategic variables we found that the creation and capturing of blue oceans were achieved by small and large companies, by young and 12 B LU E O C E A N S T R AT E G Y old managers, by companies in attractive and unattractive indus- tries, by new entrants and established incumbents, by private and public companies, by companies in low- and high-tech industries, and by companies of diverse national origins. Our analysis failed to find any perpetually excellent company or industry. What we did find behind the seemingly idiosyncratic suc- cess stories, however, was a consistent and common pattern across strategic moves for creating and capturing blue oceans. Whether it was Ford in 1908 with the Model T; GM in 1924 with cars styled to appeal to the emotions; CNN in 1980 with real-time news 24/7; or Compaq, Starbucks, Southwest Airlines, or Cirque du Soleil—or, for that matter, any of the other blue ocean moves in our study—the approach to strategy in creating blue oceans was consistent across time regardless of industry. Our research also reached out to em- brace famous strategic moves in public sector turnarounds. Here we found a strikingly similar pattern. Value Innovation: The Cornerstone of Blue Ocean Strategy What consistently separated winners from losers in creating blue oceans was their approach to strategy. The companies caught in the red ocean followed a conventional approach, racing to beat the competition by building a defensible position within the existing industry order.16 The creators of blue oceans, surprisingly, didn’t use the competition as their benchmark.17 Instead, they followed a different strategic logic that we call value innovation. Value inno- vation is the cornerstone of blue ocean strategy. We call it value in- novation because instead of focusing on beating the competition, you focus on making the competition irrelevant by creating a leap in value for buyers and your company, thereby opening up new and uncontested market space. Value innovation places equal emphasis on value and innova- tion. Value without innovation tends to focus on value creation on  Creating Blue Oceans 13 an incremental scale, something that improves value but is not suf- ficient to make you stand out in the marketplace.18 Innovation with- out value tends to be technology-driven, market pioneering, or futuristic, often shooting beyond what buyers are ready to accept and pay for.19 In this sense, it is important to distinguish between value innovation as opposed to technology innovation and market pioneering. Our study shows that what separates winners from los- ers in creating blue oceans is neither bleeding-edge technology nor “timing for market entry.” Sometimes these exist; more often, how- ever, they do not. Value innovation occurs only when companies align innovation with utility, price, and cost positions. If they fail to anchor innovation with value in this way, technology innovators and market pioneers often lay the eggs that other companies hatch. Value innovation is a new way of thinking about and executing strategy that results in the creation of a blue ocean and a break from the competition. Importantly, value innovation defies one of the most commonly accepted dogmas of competition-based strat- egy: the value-cost trade-off.20 It is conventionally believed that companies can either create greater value to customers at a higher cost or create reasonable value at a lower cost. Here strategy is seen as making a choice between differentiation and low cost.21 In contrast, those that seek to create blue oceans pursue differentia- tion and low cost simultaneously. Let’s return to the example of Cirque du Soleil. Pursuing differ- entiation and low cost simultaneously lies at the heart of the enter- tainment experience it created. At the time of its debut, other circuses focused on benchmarking one another and maximizing their share of already shrinking demand by tweaking traditional circus acts. This included trying to secure more famous clowns and lion tamers, a strategy that raised circuses’ cost structure without substantially altering the circus experience. The result was rising costs without rising revenues, and a downward spiral of overall cir- cus demand. These efforts were made irrelevant when Cirque du Soleil ap- peared. Neither an ordinary circus nor a classic theater production, 14 B LU E O C E A N S T R AT E G Y Cirque du Soleil paid no heed to what the competition did. Instead of following the conventional logic of outpacing the competition by offering a better solution to the given problem—creating a cir- cus with even greater fun and thrills—it sought to offer people the fun and thrill of the circus and the intellectual sophistication and artistic richness of the theater at the same time; hence, it redefined the problem itself.22 By breaking the market boundaries of theater and circus, Cirque du Soleil gained a new understanding not only of circus customers but also of circus noncustomers: adult theater customers. This led to a whole new circus concept that broke the value-cost trade-off and created a blue ocean of new market space. Consider the differences. Whereas other circuses focused on offering animal shows, hiring star performers, presenting multiple show arenas in the form of three rings, and pushing aisle concession sales, Cirque du Soleil did away with all these factors. These factors had long been taken for granted in the traditional circus industry, which never questioned their ongoing relevance. However, there was in- creasing public discomfort with the use of animals. Moreover, ani- mal acts were one of the most expensive elements, including not only the cost of the animals but also their training, medical care, housing, insurance, and transportation. Similarly, while the circus industry focused on featuring stars, in the mind of the public the so-called stars of the circus were trivial next to movie stars. Again, they were a high-cost component carry- ing little sway with spectators. Gone, too, are three-ring venues. Not only did this arrangement create angst among spectators as they rapidly switched their gaze from one ring to the other, but it also increased the number of performers needed, with obvious cost implications. And although aisle concession sales appeared to be a good way to generate revenue, in practice the high prices discour- aged audiences from making purchases and made them feel they were being taken for a ride. The lasting allure of the traditional circus came down to only three key factors: the tent, the clowns, and the classic acrobatic  Creating Blue Oceans 15 acts such as the wheelman and short stunts. So Cirque du Soleil kept the clowns but shifted their humor from slapstick to a more en- chanting, sophisticated style. It glamorized the tent, an element that, ironically, many circuses had begun to forfeit in favor of rented venues. Seeing that this unique venue symbolically cap- tured the magic of the circus, Cirque du Soleil designed the classic symbol of the circus with a glorious external finish and a higher level of comfort, making its tents reminiscent of the grand epic cir- cuses. Gone were the sawdust and hard benches. Acrobats and other thrilling acts are retained, but their roles were reduced and made more elegant by the addition of artistic flair and intellectual wonder to the acts. By looking across the market boundary of theater, Cirque du Soleil also offered new noncircus factors, such as a story line and, with it, intellectual richness, artistic music and dance, and multiple productions. These factors, entirely new creations for the circus in- dustry, are drawn from the alternative live entertainment industry of theater. Unlike traditional circus shows having a series of unrelated acts, for example, each Cirque du Soleil creation has a theme and story line, somewhat resembling a theater performance. Although the theme is vague (and intentionally so), it brings harmony and an intellectual element to the show—without limiting the potential for acts. Le Cirque also borrows ideas from Broadway shows. For example, it features multiple productions rather than the traditional “one for all” shows. As with Broadway shows, too, each Cirque du Soleil show has an original score and assorted music, which drives the visual performance, lighting, and timing of the acts rather than the other way around. The shows feature abstract and spiritual dance, an idea derived from theater and ballet. By introducing these new factors into its offering, Cirque du Soleil has created more sophisticated shows. Moreover, by injecting the concept of multiple productions and by giving people a reason to come to the circus more frequently, Cirque du Soleil has dramatically increased demand. 16 B LU E O C E A N S T R AT E G Y In short, Cirque du Soleil offers the best of both circus and theater, and it has eliminated or reduced everything else. By offering un- precedented utility, Cirque du Soleil has created a blue ocean and has invented a new form of live entertainment, one that is markedly different from both traditional circus and theater. At the same time, by eliminating many of the most costly elements of the circus, it has dramatically reduced its cost structure, achieving both differentia- tion and low cost. Le Cirque strategically priced its tickets against those of the theater, lifting the price point of the circus industry by several multiples while still pricing its productions to capture the mass of adult customers, who were used to theater prices. Figure 1-2 depicts the differentiation–low cost dynamics under- pinning value innovation. F I G U R E 1-2 Value Innovation: The Cornerstone of Blue Ocean Strategy Value innovation is created in the region where a company’s actions favorably affect both its cost structure and its value proposition to buyers. Cost savings are made by eliminating and reducing the factors an industry competes on. Buyer value is lifted by raising and creating elements the industry has never offered. Over time, costs are reduced further as scale economies kick in due to the high sales volumes that superior value generates. Costs Value Innovation Buyer Value The Simultaneous Pursuit of Differentiation and Low Cost  Creating Blue Oceans 17 As shown in figure 1-2, the creation of blue oceans is about driv- ing costs down while simultaneously driving value up for buyers. This is how a leap in value for both the company and its buyers is achieved. Because buyer value comes from the utility and price that the company offers to buyers and because the value to the com- pany is generated from price and its cost structure, value innova- tion is achieved only when the whole system of the company’s utility, price, and cost activities is properly aligned. It is this whole-system approach that makes the creation of blue oceans a sustainable strategy. Blue ocean strategy integrates the range of a firm’s func- tional and operational activities. In contrast, innovations such as production innovations can be achieved at the subsystem level without impacting the company’s overall strategy. An innovation in the production process, for exam- ple, may lower a company’s cost structure to reinforce its existing cost leadership strategy without changing the utility proposition of its offering. Although innovations of this sort may help to secure and even lift a company’s position in the existing market space, such a subsystem approach will rarely create a blue ocean of new market space. In this sense, value innovation is more than innovation. It is about strategy that embraces the entire system of a company’s ac- tivities.23 Value innovation requires companies to orient the whole system toward achieving a leap in value for both buyers and them- selves. Absent such an integral approach, innovation will remain divided from the core of strategy.24 Figure 1-3 outlines the key defining features of red and blue ocean strategies. Competition-based red ocean strategy assumes that an indus- try’s structural conditions are given and that firms are forced to compete within them, an assumption based on what the academics call the structuralist view, or environmental determinism.25 In con- trast, value innovation is based on the view that market boundaries and industry structure are not given and can be reconstructed by the actions and beliefs of industry players. We call this the 18 B LU E O C E A N S T R AT E G Y F I G U R E 1-3 Red Ocean Versus Blue Ocean Strategy Red Ocean Strategy Blue Ocean Strategy Compete in existing market space. Create uncontested market space. Beat the competition. Make the competition irrelevant. Exploit existing demand. Create and capture new demand. Make the value-cost trade-off. Break the value-cost trade-off. Align the whole system of a firm’s activities Align the whole system of a firm’s with its strategic choice of differentiation activities in pursuit of differentiation or low cost. and low cost. reconstructionist view. In the red ocean, differentiation costs be- cause firms compete with the same best-practice rule. Here, the strategic choices for firms are to pursue either differentiation or low cost. In the reconstructionist world, however, the strategic aim is to create new best-practice rules by breaking the existing value- cost trade-off and thereby creating a blue ocean. (For more discus- sions on this, see appendix B, “Value Innovation: A Reconstruc- tionist View of Strategy.”) Cirque du Soleil broke the best practice rule of the circus indus- try, achieving both differentiation and low cost by reconstructing elements across existing industry boundaries. Is Cirque du Soleil, then, really a circus, with all that it eliminated, reduced, raised, and created? Or is it theater? And if it is theater, then what genre— a Broadway show, an opera, a ballet? It is not clear. Cirque du Soleil reconstructed elements across these alternatives, and, in the end, it is simultaneously a little of all of them and none of any of them in their entirety. It created a blue ocean of new, uncontested market space that as of yet has no agreed-on industry name.  Creating Blue Oceans 19 Formulating and Executing Blue Ocean Strategy Although economic conditions indicate the rising imperative of blue oceans, there is a general belief that the odds of success are lower when companies venture beyond existing industry space.26 The issue is how to succeed in blue oceans. How can companies system- atically maximize the opportunities while simultaneously minimiz- ing the risks of formulating and executing blue ocean strategy? If you lack an understanding of the opportunity-maximizing and risk- minimizing principles driving the creation and capture of blue oceans, the odds will be lengthened against your blue ocean initiative. Of course, there is no such thing as a riskless strategy.27 Strategy will always involve both opportunity and risk, be it a red ocean or a blue ocean initiative. But at present the playing field is dramati- cally unbalanced in favor of tools and analytical frameworks to succeed in red oceans. As long as this remains true, red oceans will continue to dominate companies’ strategic agenda even as the busi- ness imperative for creating blue oceans takes on new urgency. Per- haps this explains why, despite prior calls for companies to go beyond existing industry space, companies have yet to act seriously on these recommendations. This book seeks to address this imbalance by laying out a method- ology to support our thesis. Here we present the principles and ana- lytical frameworks to succeed in blue oceans. Chapter 2 introduces the analytical tools and frameworks that are essential for creating and capturing blue oceans. Although supplementary tools are introduced in other chapters as needed, these basic analytics are used throughout the book. Companies can make proactive changes in industry or market fundamentals through the purposeful application of these blue ocean tools and frameworks, which are grounded in the issues of both opportunity and risk. Subsequent chapters introduce the principles that drive 20 B LU E O C E A N S T R AT E G Y the successful formulation and implementation of blue ocean strat- egy and explain how they, along with the analytics, are applied in action. There are four guiding principles for the successful formulation of blue ocean strategy. Chapters 3 to 6 address these in turn. Chap- ter 3 identifies the paths by which you can systematically create un- contested market space across diverse industry domains, hence attenuating search risk. It teaches you how to make the competition irrelevant by looking across the six conventional boundaries of competition to open up commercially important blue oceans. The six paths focus on looking across alternative industries, across strategic groups, across buyer groups, across complementary prod- uct and service offerings, across the functional-emotional orienta- tion of an industry, and even across time. Chapter 4 shows how to design a company’s strategic planning process to go beyond incremental improvements to create value in- novations. It presents an alternative to the existing strategic plan- ning process, which is often criticized as a number-crunching exercise that keeps companies locked into making incremental im- provements. This principle tackles planning risk. Using a visualiz- ing approach that drives you to focus on the big picture rather than to be submerged in numbers and jargon, this chapter proposes a four-step planning process whereby you can build a strategy that creates and captures blue ocean opportunities. Chapter 5 shows how to maximize the size of a blue ocean. To create the greatest market of new demand, this chapter challenges the conventional practice of aiming for finer segmentation to bet- ter meet existing customer preferences. This practice often results in increasingly small target markets. Instead, this chapter shows you how to aggregate demand, not by focusing on the differences that separate customers but by building on the powerful commonal- ities across noncustomers to maximize the size of the blue ocean being created and new demand being unlocked, hence minimizing scale risk.  Creating Blue Oceans 21 Chapter 6 lays out the design of a strategy that allows you not only to provide a leap in value to the mass of buyers but also to build a viable business model to produce and maintain profitable growth for itself. It shows you how to ensure that your company builds a business model that profits from the blue ocean it is creat- ing. It addresses business model risk. The chapter articulates the sequence in which you should create a strategy to ensure that both you and your customers win as you create new business ter- rain. Such a strategy follows the sequence of utility, price, cost, and adoption. Chapters 7 and 8 turn to the principles that drive effective execu- tion of blue ocean strategy. Specifically, chapter 7 introduces what we call tipping point leadership. Tipping point leadership shows managers how to mobilize an organization to overcome the key or- ganizational hurdles that block the implementation of a blue ocean strategy. It deals with organizational risk. It lays out how leaders and managers alike can surmount the cognitive, resource, motiva- tional, and political hurdles in spite of limited time and resources in executing blue ocean strategy. Chapter 8 argues for the integration of execution into strategy making, thus motivating people to act on and execute a blue ocean strategy in a sustained way deep in an organization. This chapter F I G U R E 1-4 The Six Principles of Blue Ocean Strategy Formulation principles Risk factor each principle attenuates Reconstruct market boundaries ↓ Search risk Focus on the big picture, not the numbers ↓ Planning risk Reach beyond existing demand ↓ Scale risk Get the strategic sequence right ↓ Business model risk Execution principles Risk factor each principle attenuates Overcome key organizational hurdles ↓ Organizational risk Build execution into strategy ↓ Management risk 22 B LU E O C E A N S T R AT E G Y introduces what we call fair process. Because a blue ocean strategy perforce represents a departure from the status quo, this chapter shows how fair process facilitates both strategy making and execu- tion by mobilizing people for the voluntary cooperation needed to execute blue ocean strategy. It deals with management risk associ- ated with people’s attitudes and behaviors. Figure 1-4 highlights the six principles driving the successful formulation and execution of blue ocean strategy and the risks that these principles attenuate. Chapter 9 discusses the dynamic aspects of blue ocean strategy— the issues of sustainability and renewal. Let’s now move on to chapter 2, where we lay out the basic ana- lytical tools and frameworks that will be used throughout this book in the formulation and execution of blue ocean strategy. CHAPTER 2 ) ) ) ) ( ( ( ( Analytical Tools and Frameworks W developing a E H AV E S P E N T T H E PA S T D E C A D E set of analytical tools and frameworks in an attempt to make the formulation and execution of blue ocean strategy as systematic and actionable as competing in the red waters of known market space. These analytics fill a central void in the field of strategy, which has developed an impressive array of tools and frameworks to compete in red oceans, such as the five forces for analyzing existing industry conditions and three generic strate- gies, but has remained virtually silent on practical tools to excel in blue oceans. Instead, executives have received calls to be brave and entrepreneurial, to learn from failure, and to seek out revolution- aries. Although thought-provoking, these are not substitutes for analytics to navigate successfully in blue waters. In the absence of analytics, executives cannot be expected to act on the call to break out of existing competition. Effective blue ocean strategy should be about risk minimization and not risk taking. 24 B LU E O C E A N S T R AT E G Y To address this imbalance, we studied companies around the world and developed practical methodologies in the quest of blue oceans. We then applied and tested these tools and frameworks in action by working with companies in their pursuit of blue oceans, enriching and refining them in the process. The tools and frame- works presented here are used throughout this book as we discuss the six principles of formulating and executing blue ocean strat- egy. As a brief introduction to these tools and frameworks, let’s look at one industry—the U.S. wine industry—to see how these tools can be applied in practice in the creation of blue oceans. The United States has the third largest aggregate consumption of wine worldwide. Yet the $20 billion industry is intensely compet- itive. California wines dominate the domestic market, capturing two-thirds of all U.S. wine sales. These wines compete head-to-head with imported wines from France, Italy, and Spain and New World wines from countries such as Chile, Australia, and Argentina, which have increasingly targeted the U.S. market. With the supply of wines increasing from Oregon, Washington, and New York state and with newly mature vineyard plantings in California, the number of wines has exploded. Yet the U.S. consumer base has essentially remained stagnant. The United States remains stuck at thirty-first place in world per capita wine consumption. The intense competition has fueled ongoing industry consolida- tion. The top eight companies produce more than 75 percent of the wine in the United States, and the estimated one thousand six hun- dred other wineries produce the remaining 25 percent. The domi- nance of a few key players allows them to leverage distributors to gain shelf space and put millions of dollars into above-the-line mar- keting budgets. There is a simultaneous consolidation of retailers and distributors across the United States, something that raises their bargaining power against the plethora of wine makers. Ti- tanic battles are being fought for retail and distribution space. It is no surprise that weak, poorly run companies are increasingly being swept aside. Downward pressure on wine prices has set in.  Analytical Tools and Frameworks 25 In short, the U.S. wine industry faces intense competition, mounting price pressure, increasing bargaining power on the part of retail and distribution channels, and flat demand despite over- whelming choice. Following conventional strategic thinking, the industry is hardly attractive. For strategists, the critical question is, How do you break out of this red ocean of bloody competition to make the competition irrelevant? How do you open up and capture a blue ocean of uncontested market space? To address these questions, we turn to the strategy canvas, an analytic framework that is central to value innovation and the cre- ation of blue oceans. The Strategy Canvas The strategy canvas is both a diagnostic and an action framework for building a compelling blue ocean strategy. It serves two pur- poses. First, it captures the current state of play in the known mar- ket space. This allows you to understand where the competition is currently investing, the factors the industry currently competes on in products, service, and delivery, and what customers receive from the existing competitive offerings on the market. Figure 2-1 cap- tures all this information in graphic form. The horizontal axis cap- tures the range of factors the industry competes on and invests in. In the case of the U.S. wine industry, there are seven principal factors: Price per bottle of wine An elite, refined image in packaging, including labels an- nouncing the wine medals won and the use of esoteric enologi- cal terminology to stress the art and science of wine making Above-the-line marketing to raise consumer awareness in a crowded market and to encourage distributors and retailers to give prominence to a particular wine house 26 B LU E O C E A N S T R AT E G Y F I G U R E 2-1 The Strategy Canvas of the U.S. Wine Industry in the Late 1990s High Premium Wines Budget Wines Low Price Above-the-line Vineyard prestige Wine Use of enological marketing Aging and legacy Wine range terminology and quality complexity distinctions in wine communication Aging quality of wine The prestige of a wine’s vineyard and its legacy (hence the appellations of estates and chateaux and references to the historic age of the establishment) The complexity and sophistication of a wine’s taste, includ- ing such things as tannins and oak A diverse range of wines to cover all varieties of grapes and consumer preferences from Chardonnay to Merlot, and so on These factors are viewed as key to the promotion of wine as a unique beverage for the informed wine drinker, worthy of special occasions. That is the underlying structure of the U.S. wine industry from the market perspective. Now let’s turn to the vertical axis of the  Analytical Tools and Frameworks 27 strategy canvas, which captures the offering level that buyers re- ceive across all these key competing factors. A high score means that a company offers buyers more, and hence invests more, in that factor. In the case of price, a higher score indicates a higher price. We can now plot the current offering of wineries across all these factors to understand wineries’ strategic profiles, or value curves. The value curve, the basic component of the strategy canvas, is a graphic depiction of a company’s relative performance across its industry’s factors of competition. Figure 2-1 shows that, although more than one thousand six hundred wineries participate in the U.S. wine industry, from the buyer’s point of view there is enormous convergence in their value curves. Despite the plethora of competitors, when premium brand wines are plotted on the strategy canvas we discover that from the market point of view all of them essentially have the same strategic profile. They offer a high price and present a high level of offering across all the key competing factors. Their strategic profile follows a classic differentiation strategy. From the market point of view, however, they are all different in the same way. On the other hand, budget wines also have the same essential strategic profile. Their price is low, as is their offering across all the key competing factors. These are classic low-cost players. Moreover, the value curves of premium and low-cost wines share the same basic shape. The two strategic groups’ strategies march in lockstep, but at different alti- tudes of offering level. To set a company on a strong, profitable growth trajectory in the face of these industry conditions, it won’t work to benchmark com- petitors and try to outcompete them by offering a little more for a little less. Such a strategy may nudge sales up but will hardly drive a company to open up uncontested market space. Nor is conducting extensive customer research the path to blue oceans. Our research found that customers can scarcely imagine how to create uncontested market space. Their insight also tends toward the familiar “offer me more for less.” And what customers typically want “more” of are those product and service features that the industry currently offers. 28 B LU E O C E A N S T R AT E G Y To fundamentally shift the strategy canvas of an industry, you must begin by reorienting your strategic focus from competitors to alternatives, and from customers to noncustomers of the industry.1 To pursue both value and cost, you should resist the old logic of benchmarking competitors in the existing field and choosing be- tween differentiation and cost leadership. As you shift your strategic focus from current competition to alternatives and noncustomers, you gain insight into how to redefine the problem the industry fo- cuses on and thereby reconstruct buyer value elements that reside across industry boundaries. Conventional strategic logic, by con- trast, drives you to offer better solutions than your rivals to exist- ing problems defined by your industry. In the case of the U.S. wine industry, conventional wisdom caused wineries to focus on overdelivering on prestige and the quality of wine at its price point. Overdelivery meant adding complexity to the wine based on taste profiles shared by wine makers and rein- forced by the wine show judging system. Wine makers, show judges, and knowledgeable drinkers concur that complexity—layered per- sonality and characteristics that reflect the uniqueness of the soil, season, and wine maker’s skill in tannins, oak, and aging pro- cesses—equates with quality. By looking across alternatives, however, Casella Wines, an Aus- tralian winery, redefined the problem of the wine industry to a new one: how to make a fun and nontraditional wine that’s easy to drink for everyone. Why? In looking at the demand side of the alter- natives of beer, spirits, and ready-to-drink cocktails, which cap- tured three times as many U.S. consumer alcohol sales as wine, Casella Wines found that the mass of American adults saw wine as a turnoff. It was intimidating and pretentious, and the complexity of wine’s taste created flavor challenges for the average person even though it was the basis on which the industry fought to excel. With this insight, Casella Wines was ready to explore how to redraw the strategic profile of the U.S. wine industry to create a blue ocean. To achieve this, it turned to the second basic analytic underlying blue oceans: the four actions framework.  Analytical Tools and Frameworks 29 The Four Actions Framework To reconstruct buyer value elements in crafting a new value curve, we have developed the four actions framework. As shown in figure 2-2, to break the trade-off between differentiation and low cost and to create a new value curve, there are four key questions to chal- lenge an industry’s strategic logic and business model: Which of the factors that the industry takes for granted should be eliminated? Which factors should be reduced well below the industry’s standard? Which factors should be raised well above the industry’s standard? Which factors should be created that the industry has never offered? F I G U R E 2-2 The Four Actions Framework Reduce Which factors should be reduced well below the industry’s standard? Eliminate Create Which of the factors A New Which factors should that the industry Value be created that takes for granted Curve the industry has should be eliminated? never offered? Raise Which factors should be raised well above the industry’s standard? 30 B LU E O C E A N S T R AT E G Y The first question forces you to consider eliminating factors that companies in your industry have long competed on. Often those factors are taken for granted even though they no longer have value or may even detract from value. Sometimes there is a funda- mental change in what buyers value, but companies that are fo- cused on benchmarking one another do not act on, or even perceive, the change. The second question forces you to determine whether products or services have been overdesigned in the race to match and beat the competition. Here, companies overserve customers, increasing their cost structure for no gain. The third question pushes you to uncover and eliminate the com- promises your industry forces customers to make. The fourth question helps you to discover entirely new sources of value for buyers and to create new demand and shift the strategic pricing of the industry. It is by pursuing the first two questions (of eliminating and re- ducing) that you gain insight into how to drop your cost structure vis-à-vis competitors. Our research has found that rarely do man- agers systematically set out to eliminate and reduce their invest- ments in factors that an industry competes on. The result is mounting cost structures and complex business models. The sec- ond two factors, by contrast, provide you with insight into how to lift buyer value and create new demand. Collectively, they allow you to systematically explore how you can reconstruct buyer value elements across alternative industries to offer buyers an entirely new experience, while simultaneously keeping your cost structure low. Of particular importance are the actions of eliminating and creating, which push companies to go beyond value maximization exercises with existing factors of competition. Eliminating and creating prompt companies to change the factors themselves, hence making the existing rules of competition irrelevant. When you apply the four actions framework to the strategy can- vas of your industry, you get a revealing new look at old perceived truths. In the case of the U.S. wine industry, by thinking in terms of these four actions vis-à-vis the current industry logic and looking  Analytical Tools and Frameworks 31 across alternatives and noncustomers, Casella Wines created [yel- low tail], a wine whose strategic profile broke from the competition and created a blue ocean. Instead of offering wine as wine, Casella created a social drink accessible to everyone: beer drinkers, cock- tail drinkers, and other drinkers of nonwine beverages. In the space of two years, the fun, social drink [yellow tail] emerged as the fastest growing brand in the histories of both the Australian and the U.S. wine industries and the number one imported wine into the United States, surpassing the wines of France and Italy. By August 2003 it was the number one red wine in a 750-ml bottle sold in the United States, outstripping California labels. By mid-2003, [yellow tail]’s moving average annual sales were tracking at 4.5 mil- lion cases. In the context of a global wine glut, [yellow tail] has been racing to keep up with sales. What’s more, whereas large wine companies developed strong brands over decades of marketing investment, [yellow tail] leap- frogged tall competitors with no promotional campaign, mass media, or consumer advertising. It didn’t simply steal sales from competi- tors; it grew the market. [yellow tail] brought nonwine drinkers— beer and ready-to-drink cocktail consumers—into the wine market. Moreover, novice table wine drinkers started to drink wine more frequently, jug wine drinkers moved up, and drinkers of more ex- pensive wines moved down to become consumers of [yellow tail]. Figure 2-3 shows the extent to which the application of these four actions led to a break from the competition in the U.S. wine in- dustry. Here we can graphically compare [yellow tail]’s blue ocean strategy with the more than one thousand six hundred wineries competing in the United States. As shown in figure 2-3, [yellow tail]’s value curve stands apart. Casella Wines acted on all four ac- tions—eliminate, reduce, raise, and create—to unlock uncontested market space that changed the face of the U.S. wine industry in a span of two years. By looking at the alternatives of beer and ready-to-drink cock- tails and thinking in terms of noncustomers, Casella Wines created three new factors in the U.S. wine industry—easy drinking, easy to 32 B LU E O C E A N S T R AT E G Y F I G U R E 2-3 The Strategy Canvas of [yellow tail] High Premium Wines [yellow tail] Budget Wines Low Price Above-the-line Vineyard prestige Wine Ease of marketing and legacy range selection Use of enological Aging Wine Easy Fun and terminology and quality complexity drinking adventure distinctions in wine communication select, and fun and adventure—and eliminated or reduced every- thing else. Casella Wines found that the mass of Americans rejected wine because its complicated taste was difficult to appreciate. Beer and ready-to-drink cocktails, for example, were much sweeter and easier to drink. Accordingly, [yellow tail] was a completely new combination of wine characteristics that produced an uncom- plicated wine structure that was instantly appealing to the mass of alcohol drinkers. The wine was soft in taste and approachable like ready-to-drink cocktails and beer, and had up-front, primary fla- vors and pronounced fruit flavors. The sweet fruitiness of the wine also kept people’s palate fresher, allowing them to enjoy another glass of wine without thinking about it. The result was an easy- drinking wine that did not require years to develop an apprecia- tion for.  Analytical Tools and Frameworks 33 In line with this simple fruity sweetness, [yellow tail] dramati- cally reduced or eliminated all the factors the wine industry had long competed on—tannins, oak, complexity, and aging—in crafting fine wine, whether it was for the premium or the budget segment. With the need for aging eliminated, the needed working capital for aging wine at Casella Wines was also reduced, creating a faster payback for the wine produced. The wine industry criticized the sweet fruitiness of [yellow tail] wine, seeing it as significantly low- ering the quality of wine and working against proper appreciation of fine grapes and historic wine craftsmanship. These claims may have been true, but customers of all sorts loved the wine. Wine retailers in the United States offered buyers aisles of wine varieties, but to the general consumer the choice was overwhelm- ing and intimidating. The bottles looked the same, labels were com- plicated with enological terminology understandable only to the wine connoisseur or hobbyist, and the choice was so extensive that salesclerks at retail shops were at an equal disadvantage in under- standing or recommending wine to bewildered potential buyers. Moreover, the rows of wine choice fatigued and demotivated cus- tomers, making selection a difficult process that left the average wine purchaser insecure with the choice. [yellow tail] changed all that by creating ease of selection. It dra- matically reduced the range of wines offered, creating only two: Chardonnay, the most popular white in the United States, and a red, Shiraz. It removed all technical jargon from the bottles and created instead a striking, simple, and nontraditional label featur- ing a kangaroo in bright, vibrant colors of orange and yellow on a black background. The wine boxes [yellow tail] came in were also of the same vibrant colors, with the name [yellow tail] printed boldly on the sides; the boxes served the dual purpose of acting as eye- catching, unintimidating displays for the wine. [yellow tail] hit a home run in ease of selection when it made re- tail shop employees the ambassadors of [yellow tail] by giving them Australian outback clothing, including bushman’s hats and oilskin 34 B LU E O C E A N S T R AT E G Y jackets to wear at work. The retail employees were inspired by the branded clothing and having a wine they themselves did not feel in- timidated by, and recommendations to buy [yellow tail] flew out of their mouths. In short, it was fun to recommend [yellow tail]. The simplicity of offering only two wines at the start—a red and a white—streamlined Casella Wines’ business model. Minimizing the stockkeeping units maximized its stock turnover and mini- mized investment in warehouse inventory. In fact, this reduction of variety was carried over to the bottles inside the cases. [yellow tail] broke industry conventions. Casella Wines was the first company to put both red and white wine in the same-shaped bottle, a practice that created further simplicity in manufacturing and purchasing and resulted in stunningly simple wine displays. The wine industry worldwide was proud to promote wine as a re- fined beverage with a long history and tradition. This is reflected in the target market for the United States: educated professionals in the upper income brackets. Hence, the continuous focus on the quality and legacy of the vineyard, the chateau’s or estate’s histori- cal tradition, and the wine medals won. Indeed the growth strate- gies of the major players in the U.S. wine industry were targeted at the premium end of the market, with tens of millions invested in brand advertising to strengthen this image. By looking to beer and ready-to-drink cocktail customers, however, [yellow tail] found that this elite image did not resonate with the general public, which found it intimidating. So [yellow tail] broke with tradition and cre- ated a personality that embodied the characteristics of the Aus- tralian culture: bold, laid back, fun, and adventurous. Approacha- bility was the mantra: “The essence of a great land... Australia.” There was no traditional winery image. The lowercase spelling of the name [yellow tail], coupled with the vibrant colors and the kan- garoo motif, echoed Australia. And indeed no reference to the vine- yard was made on the bottle. The wine promised to jump from the glass like an Aussie kangaroo. The result is that [yellow tail] appealed to a broad cross section of alcohol beverage consumers. By offering this leap in value, [yel-  Analytical Tools and Frameworks 35 low tail] raised the price of its wines above the budget market, pric- ing them at $6.99 a bottle, more than double the price of a jug wine. From the moment the wine hit the retail shelves in July 2001, sales took off. The Eliminate-Reduce-Raise-Create Grid There is a third tool that is key to creation of blue oceans. It is a supplementary analytic to the four actions framework called the eliminate-reduce-raise-create grid (see figure 2-4). The grid pushes companies not only to ask all four questions in the four actions framework but also to act on all four to create a new value curve. By driving companies to fill in the grid with the actions of eliminating and reducing as well as raising and creating, the grid gives compa- nies four immediate benefits: It pushes them to simultaneously pursue differentiation and low costs to break the value-cost trade-off. F I G U R E 2-4 Eliminate-Reduce-Raise-Create Grid: The Case of [yellow tail] Eliminate Raise Enological terminology Price versus and distinctions budget wines Aging qualities Retail store involvement Above-the-line marketing Reduce Create Wine complexity Easy drinking Wine range Ease of selection Vineyard prestige Fun and adventure 36 B LU E O C E A N S T R AT E G Y It immediately flags companies that are focused only on rais- ing and creating and thereby lifting their cost structure and often overengineering products and services—a common plight in many companies. It is easily understood by managers at any level, creating a high level of engagement in its application. Because completing the grid is a challenging task, it drives companies to robustly scrutinize every factor the industry competes on, making them discover the range of implicit assumptions they make unconsciously in competing. Figure 2-5, the eliminate-reduce-raise-create grid for Cirque du Soleil, provides another snapshot of this tool in action and shows what it reveals. Worth noting is the range of factors that an indus- try has long competed on that companies discover can be elimi- nated and reduced. In the case of Cirque du Soleil, it eliminated several factors from traditional circuses, such as animal shows, F I G U R E 2-5 Eliminate-Reduce-Raise-Create Grid: The Case of Cirque du Soleil Eliminate Raise Star performers Unique venue Animal shows Aisle concession sales Multiple show arenas Reduce Create Fun and humor Theme Thrill and danger Refined environment Multiple productions Artistic music and dance  Analytical Tools and Frameworks 37 star performers, and multiple show arenas. These factors had long been taken for granted in the traditional circus industry, which never questioned their ongoing relevance. However, there was in- creasing public discomfort with the use of animals. Moreover, ani- mal acts are one of the most expensive elements; not only is there the cost of the animals, but also their training, medical care, hous- ing, insurance, and transportation. Similarly, although the circus industry focused on featuring stars, in the mind of the public the so-called stars of the circus were trivial next to movie stars. Again, they were a high-cost component carrying little sway with specta- tors. Gone, too, are three-ring venues. Not only did these create angst among spectators as they rapidly switched their gaze from one ring to the other, but they also increased the number of per- formers needed, with the obvious cost implications. Three Characteristics of a Good Strategy [yellow tail], like Cirque du Soleil, created a unique and excep- tional value curve to unlock a blue ocean. As shown in the strategy canvas, [yellow tail]’s value curve has focus; the company does not diffuse its efforts across all key factors of competition. The shape of its value curve diverges from the other players’, a result of not benchmarking competitors but instead looking across alternatives. The tagline of [yellow tail]’s strategic profile is clear: a fun and sim- ple wine to be enjoyed every day. When expressed through a value curve, then, an effective blue ocean strategy like [yellow tail]’s has three complementary quali- ties: focus, divergence, and a compelling tagline. Without these qualities, a company’s strategy will likely be muddled, undifferenti- ated, and hard to communicate with a high cost structure. The four actions of creating a new value curve should be well guided toward building a company’s strategic profile with these characteristics. These three characteristics serve as an initial litmus test of the commercial viability of blue ocean ideas. 38 B LU E O C E A N S T R AT E G Y F I G U R E 2-6 The Strategy Canvas of Southwest Airlines High Southwest Average Airlines Car Transport Low Price Lounges Hub Speed Meals Seating connectivity Friendly Frequent class service point-to- choices point departures A look at Southwest Airlines’ strategic profile illustrates how these three qualities underlie the company’s effective strategy in reinventing the short-haul airline industry via value innovation (see figure 2-6). Southwest Airlines created a blue ocean by break- ing the trade-offs customers had to make between the speed of air- planes and the economy and flexibility of car transport. To achieve this, Southwest offered high-speed transport with frequent and flexi- ble departures at prices attractive to the mass of buyers. By elimi- nating and reducing certain factors of competition and raising others in the traditional airline industry, as well as by creating new factors drawn from the alternative industry of car transport, South- west Airlines was able to offer unprecedented utility for air travel- ers and achieve a leap in value with a low-cost business model. The value curve of Southwest Airlines differs distinctively from those of its competitors in the strategy canvas. Its strategic profile is a typical example of a compelling blue ocean strategy.  Analytical Tools and Frameworks 39 Focus Every great strategy has focus, and a company’s strategic profile, or value curve, should clearly show it. Looking at Southwest’s profile, we can see at once that the company emphasizes only three factors: friendly service, speed, and frequent point-to-point departures. By focusing in this way, Southwest has been able to price against car transportation; it doesn’t make extra investments in meals, lounges, and seating choices. By contrast, Southwest’s traditional competi- tors invest in all the airline industry’s competitive factors, making it much more difficult for them to match Southwest’s prices. Invest- ing across the board, these companies let their competitors’ moves set their own agendas. Costly business models result. Divergence When a company’s strategy is formed reactively as it tries to keep up with the competition, it loses its uniqueness. Consider the simi- larities in most airlines’ meals and business-class lounges. On the strategy canvas, therefore, reactive strategists tend to share the same strategic profile. Indeed, in the case of Southwest, the value curves of the company’s competitors are virtually identical and therefore can be summarized on the strategy canvas with a single value curve. In contrast, the value curves of blue ocean strategists always stand apart. By applying the four actions of eliminating, reducing, raising, and creating, they differentiate their profiles from the in- dustry’s average profile. Southwest, for example, pioneered point- to-point travel between midsize cities; previously, the industry operated through hub-and-spoke systems. Compelling Tagline A good strategy has a clear-cut and compelling tagline. “The speed of a plane at the price of a car—whenever you need it.” That’s the tagline of Southwest Airlines, or at least it could be. What could 40 B LU E O C E A N S T R AT E G Y Southwest’s competitors say? Even the most proficient ad agency would have difficulty reducing the conventional offering of lunches, seat choices, lounges, and hub links, with standard service, slower speeds, and higher prices into a memorable tagline. A good tagline must not only deliver a clear message but also advertise an offering truthfully, or else customers will lose trust and interest. In fact, a good way to test the effectiveness and strength of a strategy is to look at whether it contains a strong and authentic tagline. As shown in figure 2-7, Cirque du Soleil’s strategic profile also meets the three criteria that define blue ocean strategy: focus, di- vergence, and a compelling tagline. Cirque du Soleil’s strategy canvas allows us to graphically compare its strategic profile with those of its major competitors. The canvas shows clearly the ex- tent of Cirque du Soleil’s departure from the conventional logic of the circus. The figure shows that the value curve of Ringling Bros. and Barnum & Bailey is the same basic shape as those of smaller regional circuses. The main difference is that regional circuses F I G U R E 2-7 The Strategy Canvas of Cirque du Soleil High Ringling Bros. and Barnum & Bailey Value Curve Cirque du Soleil Value Curve Smaller Regional Circuses Low Price Animal Multiple Thrills and Theme Multiple shows show danger productions Star Aisle arenas Fun Unique Refined Artistic performers concessions and venue watching music humor environment and dance  Analytical Tools and Frameworks 41 offer less of each competing factor because of their restricted resources. By contrast, Cirque du Soleil’s value curve stands apart. It has new and noncircus factors such as theme, multiple productions, re- fined watching environment, and artistic music and dance. These factors, entirely new creations for the circus industry, are drawn from the alternative live entertainment industry of theater. In this way, the strategy canvas clearly depicts the traditional factors that affect competition among industry players, as well as new factors that lead to creation of new market space and that shift the strat- egy canvas of an industry. [yellow tail], Cirque du Soleil, and Southwest Airlines created blue oceans in very different business situations and industrial contexts. However, their strategic profiles shared the same three characteristics: focus, divergence, and a compelling tagline. These three criteria guide companies in carrying out the process of re- construction to arrive at a breakthrough in value both for buyers and for themselves. Reading the Value Curves The strategy canvas enables companies to see the future in the pres- ent. To achieve this, companies must understand how to read value curves. Embedded in the value curves of an industry is a wealth of strategic knowledge on the current status and future of a business. A Blue Ocean Strategy The first question the value curves answer is whether a business de- serves to be a winner. When a company’s value curve, or its com- petitors’, meets the three criteria that define a good blue ocean strategy—focus, divergence, and a compelling tagline that speaks to the market—the company is on the right track. These three criteria serve as an initial litmus test of the commercial viability of blue ocean ideas. 42 B LU E O C E A N S T R AT E G Y On the other hand, when a company’s value curve lacks focus, its cost structure will tend to be high and its business model complex in implementation and execution. When it lacks divergence, a com- pany’s strategy is a me-too, with no reason to stand apart in the marketplace. When it lacks a compelling tagline that speaks to buy- ers, it is likely to be internally driven or a classic example of inno- vation for innovation’s sake with no great commercial potential and no natural take-off capability. A Company Caught in the Red Ocean When a company’s value curve converges with its competitors, it signals that a company is likely caught within the red ocean of bloody competition. A company’s explicit or implicit strategy tends to be trying to outdo its competition on the basis of cost or quality. This signals slow growth unless, by the grace of luck, the company benefits from being in an industry that is growing on its own ac- cord. This growth is not due to a company’s strategy, however, but to luck. Overdelivery Without Payback When a company’s value curve on the strategy canvas is shown to deliver high levels across all factors, the question is, Does the com- pany’s market share and profitability reflect these investments? If not, the strategy canvas signals that the company may be oversup- plying its customers, offering too much of those elements that add incremental value to buyers. To value-innovate, the company must decide which factors to eliminate and reduce—and not only those to raise and create—to construct a divergent value curve. An Incoherent Strategy When a company’s value curve looks like a bowl of spaghetti—a zigzag with no rhyme or reason, where the offering can be de- scribed as “low-high-low-low-high-low-high”—it signals that the  Analytical Tools and Frameworks 43 company doesn’t have a coherent strategy. Its strategy is likely based on independent substrategies. These may individually make sense and keep the business running and everyone busy, but col- lectively they do little to distinguish the company from the best competitor or to provide a clear strategic vision. This is often a re- flection of an organization with divisional or functional silos. Strategic Contradictions Are there strategic contradictions? These are areas where a com- pany is offering a high level on one competing factor while ignor- ing others that support that factor. An example is investing heavily in making a company’s Web site easy to use but failing to correct the site’s slow speed of operation. Strategic inconsistencies can also be found between the level of your offering and your price. For example, a petroleum station company found that it offered “less for more”: fewer services than the best competitor at a higher price. No wonder it was losing market share fast. An Internally Driven Company In drawing the strategy canvas, how does a company label the in- dustry’s competing factors? For example, does it use the word mega- hertz instead of speed, or thermal water temperature instead of hot water? Are the competing factors stated in terms buyers can under- stand and value, or are they in operational jargon? The kind of lan- guage used in the strategy canvas gives insight as to whether a company’s strategic vision is built on an “outside-in” perspective, driven by the demand side, or an “inside-out” perspective that is op- erationally driven. Analyzing the language of the strategy canvas helps a company understand how far it is from creating industry demand. The tools and frameworks introduced here are essential analytics used throughout this book, and supplementary tools are introduced 44 B LU E O C E A N S T R AT E G Y in other chapters as needed. It is the intersection between these analytic techniques and the six principles of formulating and exe- cuting blue oceans that allow companies to break from the compe- tition and unlock uncontested market space. Now we move on to the first principle, reconstructing market boundaries. In the next chapter we discuss the opportunity-maxi- mizing and risk-minimizing paths to creating blue oceans.  PA RT T WO ) ) ) ) ( ( ( ( ( Formulating Blue Ocean Strategy CHAPTER 3 ) ) ) ) ( ( ( ( Reconstruct Market Boundaries T HE FIRST PRINCIPLE of blue ocean strategy is to re- construct market boundaries to break from the compe- tition and create blue oceans. This principle addresses the search risk many companies struggle with. The challenge is to success- fully identify, out of the haystack of possibilities that exist, com- mercially compelling blue ocean opportunities. This challenge is key because managers cannot afford to be riverboat gamblers bet- ting their strategy on intuition or on a random drawing. In conducting our research, we sought to discover whether there were systematic patterns for reconstructing market boundaries to create blue oceans. And, if there were, we wanted to know whether these patterns applied across all types of industry sectors—from consumer goods, to industrial products, to finance and services, to telecoms and IT, to pharmaceuticals and B2B—or were they lim- ited to specific industries? We found clear patterns for creating blue oceans. Specifically, we found six basic approaches to remaking market boundaries. We call this the six paths framework. These paths have general applica- bility across industry sectors, and they lead companies into the 48 F O R M U L AT I N G B LU E O C E A N S T R AT E G Y corridor of commercially viable blue ocean ideas. None of these paths requires special vision or foresight about the future. All are based on looking at familiar data from a new perspective. These paths challenge the six fundamental assumptions underly- ing many companies’ strategies. These six assumptions, on which most companies hypnotically build their strategies, keep compa- nies trapped competing in red oceans. Specifically, companies tend to do the following: Define their industry similarly and focus on being the best within it Look at their industries through the lens of generally ac- cepted strategic groups (such as luxury automobiles, econ- omy cars, and family vehicles), and strive to stand out in the strategic group they play in Focus on the same buyer group, be it the purchaser (as in the office equipment industry), the user (as in the clothing indus- try), or the influencer (as in the pharmaceutical industry) Define the scope of the products and services offered by their industry similarly Accept their industry’s functional or emotional orientation Focus on the same point in time—and often on current com- petitive threats—in formulating strategy The more that companies share this conventional wisdom about how they compete, the greater the competitive convergence among them. To break out of red oceans, companies must break out of the ac- cepted boundaries that define how they compete. Instead of look- ing within these boundaries, managers need to look systematically across them to create blue oceans. They need to look across alter- native industries, across strategic groups, across buyer groups, across complementary product and service offerings, across the  Reconstruct Market Boundaries 49 functional-emotional orientation of an industry, and even across time. This gives companies keen insight into how to reconstruct market realities to open up blue oceans. Let’s examine how each of these six paths works. Path 1: Look Across Alternative Industries In the broadest sense, a company competes not only with the other firms in its own industry but also with companies in those other in- dustries that produce alternative products or services. Alternatives are broader than substitutes. Products or services that have differ- ent forms but offer the same functionality or core utility are often substitutes for each other. On the other hand, alternatives include products or services that have different functions and forms but the same purpose. For example, to sort out their personal finances, people can buy and install a financial software package, hire a CPA, or simply use pencil and paper. The software, the CPA, and the pencil are largely substitutes for each other. They have very different forms but serve the same function: helping people manage their financial affairs. In contrast, products or services can take different forms and perform different functions but serve the same objective. Consider cinemas versus restaurants. Restaurants have few physical fea- tures in common with cinemas and serve a distinct function: They provide conversational