Blue Ocean Strategy

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blue ocean strategy: from theory to practice w. chan kim renée mauborgne f or twenty-?ve..determinism. taking market structure as given, much as military strategy takes..w. chan kim and renée mauborgne. copyright © 2005 by...

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Blue Ocean Strategy pdf




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Blue Ocean Strategy - page 1
Blue Ocean Strategy: F ROM T HEORY TO P RACTICE W. Chan Kim Renée Mauborgne or twenty-five years, competition has been at the heart of corporate strategy. Today, one can hardly speak of strategy without involving the language of competition: competitive strategy, competitive benchmarking, building competitive advantages, and beating the competition. Such focus on the competition traces back to corporate strategy’s roots in military strategy. The very language of corporate strategy is deeply imbued with military references—chief executive “officers” in “headquarters,” “troops” on the “front lines,” and fighting over a defined battlefield. 1 Industrial organization (IO) economics gave formal expression to the prominent importance of competition to firms’ success. IO economics suggests a causal flow from market structure to conduct and performance. 2 Here, market structure, given by supply and demand conditions, shapes sellers’ and buyers’ conduct, which, in turn, determines end performance. 3 The academics call this the structuralist view, or environmental determinism. Taking market structure as given, much as military strategy takes land as given, such a view drives compa- nies to try to carve out a defensible position against the competition in the exist- ing market space. To sustain themselves in the marketplace, practitioners of strategy focus on building advantages over the competition, usually by assessing what competitors do and striving to do it better. Here, grabbing a bigger share of the market is also seen as a zero-sum game in which one company’s gain is achieved at another company’s loss. Hence, competition, the supply side of the equation, remains the defining variable of strategy with the focus on dividing up existing industry space. F Adapted from BLUE OCEAN STRATEGY: How to Create Uncontested Market Space and Make the Competition Irrelevant by W. Chan Kim and Renée Mauborgne. Copyright © 2005 by Harvard Busi- ness School Publishing Corporation. All Rights Reserved. CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005 105
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Blue Ocean Strategy - page 2
Blue Ocean Strategy: From Theory to Practice Not surprisingly, the result has been a fairly good understanding of how to compete skillfully in established markets, from analyzing the underlying eco- nomic structure of an existing industry to choosing a strategic position of low cost or differentiation or focus. 4 The arsenal of analytic tools and frameworks ranging from the five force framework to the value chain successfully anchored competition at the core of strategy. But should it be? Our research over the last fifteen years suggests no. Of course competition matters. However, by focusing on the strategies of competition, companies and scholars have ignored a very important—and, we would argue, more lucrative— aspect of strategy. This involves not competing, but making the competition irrelevant by creating a new market space where there are no competitors— what we call a “blue ocean.” Blue Oceans 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. 5 Here companies try to outperform their rivals to grab a greater share of existing demand. The dominant focus of strategy work over the past twenty-five years has been on competition-based red ocean strategies. 6 As the market space of red oceans gets crowded, prospects for profits and growth are reduced. Products become commodities, and cutthroat competition turns the red ocean bloody. Hence we use the term “red” oceans. Blue oceans, in contrast, are defined by untapped market space, demand creation, and the opportunity for highly profitable growth. Although some blue oceans are created well beyond existing industry boundaries, most are created from W. Chan Kim is The Boston Consulting Group within red oceans by expanding existing Bruce D. Henderson Chair Professor of Strategy and International Management at INSEAD. industry boundaries. In blue oceans, compe- <chan.kim@insead.edu> tition is irrelevant because the rules of the Renée Mauborgne is The INSEAD Distinguished game are waiting to be set. The term “blue Fellow and a professor of strategy and ocean” is an analogy to describe the wider management at INSEAD. She can be reached potential of market space that is vast, deep, at <renee.mauborgne@insead.edu> and not yet explored. It will always be important to navigate successfully in the red ocean by outcompeting rivals. Red oceans will always matter and will always be a fact of business life. However, with supply exceeding demand in more industries, com- peting for a share of contracting markets, while necessary, will not be sufficient to sustain high performance. Companies need to go beyond competing in estab- lished industries. To seize new profit and growth opportunities, they also need to create blue oceans. 106 CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005
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Blue Ocean Strategy: From Theory to Practice FIGURE 1. The Profit and Growth Consequences of Creating Blue Oceans The Impact of Creating Blue Oceans We conducted a study of business launches in 108 companies. We found that 86% of these launches were line extensions, i.e., incremental improve- ments to existing industry offerings within red oceans, while a mere 14% were aimed at creating new markets or blue oceans. While line extensions in red oceans did account for 62% of the total revenues, they only delivered 39% of the total profits. By contrast, the 14% invested in creating blue oceans delivered 38% of total revenues and a startling 61% 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 consequences, including fail- ures), the performance benefits of creating blue oceans are evident (see Figure 1). 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 indus- trial productivity and have allowed suppliers to produce an unprecedented array of products and services. The trend toward globalization compounds the situa- tion. As trade barriers between nations and regions are dismantled and as infor- mation on products and prices becomes instantly and globally available, niche markets and monopoly havens continue to disappear. 7 While supply is on the rise as global competition intensifies, there is no clear evidence of an increase in demand worldwide, and statistics even point to declining populations in many developed markets. 8 The result has been accelerated commoditization of products and services, increasing price wars, and shrinking profit margins. Recent industry-wide stud- ies on major American brands confirm this trend. 9 They reveal that for major product and service categories, brands are generally becoming more similar, CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005 107
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Blue Ocean Strategy: From Theory to Practice and as they are becoming more similar people increasingly select based on price. 10 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 both in economic upturns and in downturns. All this suggests that the business environment in which most strategy and management approaches evolved is increasingly disappearing. As red oceans become increasingly bloody, management will need to be more concerned with blue oceans than the current cohort of managers is accustomed to. 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 compa- nies venture beyond existing industry space. 11 The issue is how to succeed in blue oceans. How can companies systematically maximize the opportunities while simultaneously minimizing the risks of creating blue oceans? Of course, there is no such thing as a riskless strategy. 12 Strategy will always involve both opportunity and risk, be it a red ocean or a blue ocean ini- tiative. At present, however, there is an overabundance 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 business imperative for creating blue oceans takes on new urgency. Perhaps this explains why companies—despite prior calls to go beyond existing industry space—have yet to act seriously on these recommendations. While executives have received calls to be brave and entrepreneurial, to learn from failure, and to seek out revo- lutionaries, as thought-provoking as these ideas may be, they are not substitutes for analytics to navigate successfully in blue waters. We have spent more than a decade studying over 150 blue ocean creations in over 30 industries spanning more than 100 years from 1880 to 2000. Our central research question was whether there was a pattern by which blue oceans are created and high performance achieved. A Reconstructionist View of Strategy There are common characteristics across blue ocean creations. In sharp contrast to companies playing by traditional rules, the creators of blue oceans never used the competition as their benchmark. Instead they made it irrelevant by creating a leap in value for both buyers and the company itself. While competition-based red ocean strategy assumes that an industry’s structural conditions are given and that firms are forced to compete within them, blue ocean strategy 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 reconstructionist view. In the red ocean, differentiation costs because firms compete with the same best-practice rule. According to this thesis, companies can either create greater value to customers at a higher cost or create reasonable value at a lower cost. In other words, 108 CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005
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Blue Ocean Strategy: From Theory to Practice strategy is essentially a choice between differentiation and low cost. 13 In the reconstructionist world, however, the strategic aim is to create new rules of the game by breaking the existing value/cost trade-off and thereby creating a blue ocean. Recognizing that structure and market boundaries exist only in managers’ minds, practitioners who hold the reconstructionist view do not let existing mar- ket structures limit their thinking. To them, extra demand is out there, largely untapped. The crux of the problem is how to create it. This, in turn, requires a shift of attention from supply to demand, from a focus on competing to a focus on leaving the competition behind. It involves looking systematically across established boundaries of competition and reordering existing elements in differ- ent markets to reconstruct them into a new market space where a new level of demand is generated. 14 In the reconstructionist view, there is scarcely any attractive or unattrac- tive industry per se because the level of industry attractiveness can be altered through companies’ conscientious efforts of reconstruction. As market structure is changed in the reconstruction process, so are the rules of the game. Competi- tion in the old game is therefore rendered irrelevant. By stimulating the demand side of the economy, blue ocean strategy expands existing markets and creates new ones. The creation of blue oceans is about driving costs down while simultane- ously driving value up for buyers. This is how a leap in value for both the com- pany 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 company is generated from price and its cost structure, blue ocean strategy 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 functional and operational activities. In this sense, blue ocean strategy is more than innovation. It is about strategy that embraces the entire system of a company’s activities. 15 Analytical Frameworks and Tools In an attempt to make the formulation of blue ocean strategy as system- atic and actionable as competing in the red waters of the known market space, we studied companies around the world and developed practical methodologies in the quest of blue oceans. We then applied and tested these tools and frame- works in action by working with companies in their pursuit of blue oceans, enriching and refining them in the process in an attempt to move from a theory of reconstructionism to practical application. As a brief introduction to these tools and frameworks, the U.S. wine industry demonstrates 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 competitive. California wines dominate the domestic market, capturing two-thirds of all U.S. wine sales. CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005 109
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Blue Ocean Strategy: From Theory to Practice 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-third place in world per capita wine consumption. The intense competition has fueled ongoing industry consolidation. The top eight companies produce more than 75 percent of the wine in the United States, and the estimated one thousand six hundred other wineries produce the remaining 25 percent. There is a simultaneous consolidation of retailers and distributors across the United States, something that raises their bargaining power against the plethora of winemakers. Titanic battles are being fought for retail and distribution space. Downward pressure on wine prices has set in. In short, the U.S. wine industry faces intense competition, mounting price pressure, increasing bargaining power on the part of retail and distribution chan- nels, and flat demand despite overwhelming 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? The Strategy Canvas The strategy canvas is both a diagnostic and an action framework for building a compelling blue ocean strategy. It serves two purposes. First, it cap- tures the current state of play in the known market space. This allows you to understand where the competition is currently investing; the factors the indus- try currently competes on in products, service, and delivery; and what customers receive from the existing competitive offerings on the market. Figure 2 captures all this information in graphic form. The horizontal axis captures 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: b price per bottle of wine; b an elite, refined image in packaging, including labels announcing the wine medals won and the use of esoteric enological terminology to stress the art and science of winemaking; b above-the-line marketing to raise consumer awareness in a crowded mar- ket and to encourage distributors and retailers to give prominence to a particular wine house; b aging quality of wine; b 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); 110 CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005
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Blue Ocean Strategy: From Theory to Practice FIGURE 2. The Strategy Canvas of U.S. Wine Industry in the Late 1990s b the complexity and sophistication of a wine’s taste, including such things as tannins and oak; and b 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 mar- ket perspective. The vertical axis of the strategy canvas captures the offering level that buyers receive across all of these key competing factors. A high score means that a company offers buyers more, and hence invests more, in that fac- tor. 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 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 CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005 111
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Blue Ocean Strategy: From Theory to Practice 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 altitudes 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 competitors 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 uncon- tested market space. Their insight also tends toward the familiar “offer me more for less.” What customers typically want “more” of are those product and service features that the industry currently offers. To fundamentally shift the strategy canvas of an industry, a company must begin by reorienting its strategic focus from competitors to alternatives, and from customers to noncustomers of the industry. 16 To pursue both value and cost, companies should resist the old logic of benchmarking competitors in the exist- ing field and choosing between differentiation and cost leadership. As a com- pany shifts its strategic focus from current competition to alternatives and noncustomers, it gains insight into how to redefine the problem the industry focuses on and thereby how to reconstruct buyer value elements that reside across industry boundaries. Conventional strategic logic, by contrast, drives a company to offer better solutions than rivals to existing problems defined by an industry. In the case of the U.S. wine industry, the problem the industry focused on was how to create a more sophisticated wine for special occasions. The two strategic groups—premium wines and budget wines—both strove to better answer this question; the only difference was that the premium wines strove |to create a more sophisticated wine for special occasions for those able to spend significant money, while budget wines strove to do the same but for people on tight budgets. In essence, conventional wisdom caused wineries to focus on over-delivering on prestige and the quality of wine at its price point. Over-deliv- ery meant adding complexity to the wine based on taste profiles shared by wine- makers and reinforced by the wine show judging system. Winemakers, show judges, and knowledgeable drinkers concur that complexity—layered personal- ity and characteristics that reflect the uniqueness of the soil, season, and wine- maker’s skill in tannins, oak, and aging processes—equates with quality. By looking across alternatives, however, Casella Wines, an Australian winery, redefined the problem of the wine industry to a new one: how to make a fun and easy-to-enjoy wine for every day. Why? In looking at the demand side of the industry alternatives of beer, spirits, and ready-to-drink cocktails, which captured three times as many U.S. consumer alcohol sales as wine, Casella 112 CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005
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Blue Ocean Strategy: From Theory to Practice Wines found that the mass of American adults saw wine as a turnoff. While the noncustomers outnumbered the customers three to one, the industry, so focused on competition, had ignored this population. By looking to industry alternatives and non-customers, Casella learned that to the mass of Americans wine 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. The Four Actions Framework To reconstruct buyer value elements in crafting a new value curve, we have developed the four actions framework (see Figure 3) that asks four key questions to challenge an industry’s strategic logic and business model: b The first question forces a company to consider eliminating factors that companies in an 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 fundamental change in what buyers value, but companies that are focused on benchmarking one another do not act on, or even perceive, the change. b The second question forces a company to determine whether products or services have been over-designed in the race to match and beat the com- petition. Here, companies over-serve customers, increasing their cost structure for no gain. b The third question pushes a company to uncover and eliminate the com- promises an industry forces customers to make. b The fourth question helps a company 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 reducing) that a company gains insight into how to drop its cost structure vis-à-vis competitors. Rarely do managers systematically set out to eliminate and reduce their invest- ments in factors that an industry competes on. The result is mounting cost struc- tures and complex business models. The second two factors, by contrast, provide a company with insight into how to lift buyer value and create new demand. Collectively, they allow a company to systematically explore how it can recon- struct buyer value elements across alternative industries to offer buyers an entirely new experience, while simultaneously keeping its 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 basis of competition irrelevant. CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005 113
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Blue Ocean Strategy: From Theory to Practice FIGURE 3. The Four Actions Framework When a company applies the four actions framework to the strategy can- vas of an industry, it gets 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 across industry alternatives and non- customers, Casella Wines created [yellow 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, cocktail drinkers, and other drinkers of non-wine 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 2004, [yellow tail] sold more than 11.2 million cases to the United States alone. In the context of a global wine glut, [yellow tail] has been racing to keep up with sales. 114 CALIFORNIA MANAGEMENT REVIEW VOL. 47, NO. 3 SPRING 2005
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