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Navigating Toward 'Blue Oceans'

Creating blue oceans requires an idea that defines a new market, rather than chasing the competition

Illustration By
Tavis Coburn

By W. Chan Kim and Renée Mauborgne
February 2005, Issue 40

In three years' time, Apple Computer has emerged as one of the hottest companies in the digital-music industry. Behind its resurgence is the rising success of its iPod digital-music player and iTunes digital-music store. Since the iPod's launch in October 2001, Apple has sold more than 6 million units and captured more than 60% of the digital-music player market. And iTunes is the No. 1 digital-music store in the world, grabbing 70% of the market for legal downloads of music.

What's more interesting is that neither of these new businesses was launched in high-growth industries. Before iPod entered the scene, there were scores of simple, inexpensive flash-memory players in the digital-device industry, and also no shortage of more sophisticated and powerful hard-drive digital-jukebox MP3 players that could hold and play up to 5,000 songs. As for the digital-music download industry, people seemed unwilling to pay for digitally downloaded songs.

Companies such as Napster had inspired Internet-savvy music lovers to freely and illegally download music across the globe. By 2003, there were more than 2 billion illegal music files traded every month. Despite efforts and lawsuits to counter this, the industry was largely illegal, unprofitable, and limited to technology-savvy customers.

Apple's success in both industries wasn't based on simply stealing customers away from existing players. Instead, Apple significantly grew demand, converting the mass of noncustomers who weren't technologically savvy into customers. At the same time, Apple created powerful word-of-mouth advertising for its cool and irresistible product and service.

To understand what Apple has achieved, imagine a market composed of two kinds of ocean: red and blue. Red oceans represent all the industries in existence today. In the red ocean, companies try to outperform their rivals to capture a greater share of existing demand. As companies compete head-on, the red ocean often turns bloody and prospects for profits and growth are reduced. The main strategic thrust is endless benchmarking of competitors and trying to outdo them. In the end, the competition sets the strategic agenda.

Blue oceans, by contrast, are defined by untapped markets and the opportunity for highly profitable growth. They are vast, deep, and untouched. Here, demand is created rather than fought over. Companies that create blue oceans, like Apple, strive to make the competition irrelevant by providing a leap in value for customers and the company.

In which ocean is your strategic thinking anchored? In our research over the last decade, published in our just-released book, Blue Ocean Strategy: How to Create Uncontested Market Space and Make Competition Irrelevant (Harvard Business School Press, February 2005), we assessed the profitable-growth consequences of creating blue oceans. Our study of business launches by 108 companies showed that 86% were line extensions—that is, incremental improvements within the red ocean of their existing markets. And while those accounted for 62% of the total revenue of new-business launches, they contributed a mere 39% of total profits. By contrast, the remaining 14% of the launches were aimed at creating blue oceans. They generated 38% of new-business launches' total revenue and 61% of total profits.

Though some IT executives may not be happy to hear it, technology isn't the key driver in creating blue oceans. In fact, blue oceans aren't the same as technology innovations or bleeding-edge technology. Blue oceans come from value innovation—that is, linking innovation to what the mass of buyers value—not from technology innovation per se.

In our review of 30-plus industries, spanning more than 100 years of data, leading-edge technology wasn't found to be a defining feature in the creation of blue oceans. This was often true even for technologically intensive companies, such as Apple or Compaq. In 1992, Compaq created the multibillion-dollar blue ocean of PC servers with the launch of ProSignia, which gave buyers twice the file and print capability of the minicomputer at one-third the price. Compaq's ProSignia was a strong link between technology and what the mass of buyers valued.

Here's where technology officers often get tripped up: They think they're onto something big, which in the end may not be appreciated by the market. Bleeding-edge technology—and the advanced features that often accompany it—may impress the technologically savvy, but the more pertinent question is whether the technology is irresistible to the mass buyers your company is targeting. It's only when technology is made intuitive, unobtrusive, and user-friendly—so much so that the average person doesn't even perceive there's any technology involved—that technology officers are on the road to supporting the creation of blue oceans and value innovation. We say "on the road" because for technology to support the creation of blue oceans, CIOs must test their ideas and initiatives against a fundamentally different set of criteria.

THE DEFINING CRITERIA

When technology executives understand this, they can begin to add strategic value and function as key drivers in the quest to create uncontested markets. They can get out of the trap of benchmarking competitors—a common practice that's often counterproductive because it can lead to costly IT solutions that overdeliver what buyers actually value.

Three principal criteria define commercially compelling blue oceans. Technology officers need to understand these to add real value to their companies' strategy dialogues and to their products, services, and business models. These criteria determine whether a company's new business ideas, and the technology that underlies them, create strong, profitable growth or technological marvels that fail, such as Motorola's Iridium satellite phone.

·  Buyer utility: To address this first criterion, technology managers should ask whether the offering unlocks exceptional utility and whether there's a compelling reason for the mass of people to buy it. Absent this, there's no blue-ocean potential to start with. Unless a new business idea or technology makes buyers' lives dramatically more fun and fashionable, easier, productive, convenient, or less risky, it won't create a blue ocean.

This may seem self-evident, but companies often get it wrong. The classic example is Motorola's Iridium, which provided no attractive utility, because it wasn't usable in buildings or cars. Contrast this with the iPod, which has a user interface that's easy to use, stylish, highly portable, and holds lots of songs. With the iPod, people feel smart, productive, and hip virtually from the get-go.

In the world of personal finance, Intuit understood the difference between technology and buyer utility well. In 1984, the company created the blue ocean of personal-financial software with its Quicken product. At the time, there were 42 software products to handle personal financial needs. The market was both crowded and small. Most people preferred to use the familiar pencil to handle their personal finances.

In talking to noncustomers—the pencil users—Intuit learned the reason for this. The financial software then on the market was laden with sophisticated options people didn't understand, the user interface was intimidating, and large investments of time were required just to navigate the instruction manual and get the product installed, never mind use it.

Intuit's response: dramatically simplified personal financial software that eliminated accounting terminology and the majority of sophisticated features, and focused instead on the few basic functions that most customers use. Intuit created a user interface that looked and worked like the familiar checkbook. The result: Decades after the creation of Quicken, no company—not even Microsoft—has been able to dislodge Intuit's dominance in the blue ocean it created.

·  Strategic price: Assuming your business idea passes the exceptional-utility hurdle, the second focus is on whether the business idea is strategically priced to capture the mass of target buyers. The question to answer is: Do those buyers have a compelling ability to pay for your new offering?

Here's where the creation of blue oceans significantly departs from the conventional practices of technology innovators. The latter typically sets high prices, limits access to early adopters at the start, and initially engages in price skimming to earn a premium on the innovation, only later focusing on lowering prices to retain market share and discourage imitators.

In contrast, companies that create blue oceans aim to capture the mass of target buyers from the outset to discourage imitation, rapidly earn a brand reputation for offering radically superior value, and unleash economies of scale and learning. The focus is on creating new aggregate demand through a leap in buyer utility at an accessible price. Without a strategic price, buyers may desire your product or service, but won't be able to buy it.

With Motorola's Iridium priced at $3,000 a phone, people saw no compelling reason to switch from their $150 cell phones. Contrast this with iTunes, which lets users easily download music for 99 cents a song. Not only did people receive unprecedented utility with the easy searching and downloading of songs, but iTunes was strategically priced so that even young people would see the logic of paying to legally download songs, rather than not paying and, therefore, engaging in illegal behavior.

·  Business model: The third criterion is creating a business model that delivers exceptional utility and a strategic price while still earning a healthy profit margin. Is there a compelling ability to profit from the new offering? Blue oceans are created only when there's a leap in value for buyers in the form of utility and price, and a leap in value for the company in terms of profit earned.

FULL-STEAM AHEAD

The first action item is to determine the cost target. In our experience, companies have a hard time keeping the costs of new products, services, and technologies down, and to compensate, they usually set prices higher than is strategically wise. To create blue oceans, however, you must never let costs drive prices. By basing cost targets on the market-driven strategic price and refusing to allow for overruns, companies are forced to question virtually every assumption about materials, designs, manufacturing, and distribution—often with surprising results.

Consider: Can you develop new and cheaper assembly techniques so that, for example, ultrasound welding can replace mechanical screws, or so that material inventories can be kept to hours instead of weeks or months? Can you reduce the number of parts to be used or replace more expensive materials with less-expensive ones? Can you acquire the needed technology instead of designing and manufacturing everything in-house? Can you significantly eliminate, reduce, and outsource high-cost, low-value-added activities in your value chain? Can you reduce costs by digitizing assets or activities? By asking questions such as these, companies often discover innovative ways to hit the target cost.

Technology officers can play two important roles. First, in designing products or services with a high-technology component, they can set aggressive cost targets for the technology staff. Second, they can enlighten the business heads in strategic discussions on how technology can dramatically lower their cost structures in actualizing blue-ocean ideas.

It's well-documented that Dell and Wal-Mart use technology to achieve some of the lowest cost structures in the world and the most flexible customer offerings. If they can do it, so can you. The key for technology officers is understanding the costliest business processes underlying a new business idea, and the technologies they could bring to bear to dramatically strip the costs out. Doing this effectively requires not only a good understanding of technology—an area in which technology officers score relatively well—but also a keen understanding of a company's strategy and the products and services it offers, an area in which technology officers are often less well-versed. Yet the potential to add value is key.

Even after a company has created a blue ocean, its work isn't finished. For example, though Apple's iPod has successfully opened a blue ocean, the company needs to broaden and hold onto this edge in the future or it could be overtaken much the way Apple's home computers were. The iPod's vulnerabilities lie in its strategic pricing and target costing. With imitators increasingly pushing their way in, the company would be wise to revisit those issues.

SIDEBAR/ WILL YOUR IDEAS SWIM,  TAKE THIS TEST

To determine whether your idea will float in a blue ocean, ask this question: How does the technology make buyers' lives dramatically more productive, far simpler, more convenient, less risky, or more fun and fashionable? If you can't answer this question in a few crisp, simple sentences, you're not on the path to creating blue oceans.

Here are some indicators that you may be confusing technology innovation with blue-ocean strategy:

·  Are classes required to learn how to use your new offering?

·  Are lengthy manuals needed to understand how to install it?

·  Do customers need long explanations to understand what burning problem it solves?

If you answered yes to any of these, think again.

Another way to get started is to ask yourself: What are the alternative products and services to our new offering? Which alternative product or service captures the greatest mass of buyers, and at what price point?

Remember that alternatives are defined from the buyer's point of view, not from the vendor's. In the case of Quicken, the chief alternative to personal financial software was the pencil; therefore, Intuit priced Quicken against the pencil, not against the 42 existing software packages, to convert noncustomers into customers.—W. Chan Kim and Renée Mauborgne

THE 90- DAY PLAN

 Over the next three months, you can take several steps to transform the strategic mind-set of your employees into blue-ocean thinking. It requires not only new ideas, but a close examination of those ideas for value to the buyer and your company. Here's how you can get started.

First month: Draw distinction between innovation and blue-ocean creation

·  Drill the technology staff to think less about bleeding-edge technology and more about bleeding-edge utility from the buyer's point of view.

·  Challenge all ideas and proposals on whether they deliver radically superior utility.

·  Engage in regular dialogue with business heads, marketing, and buyers to intimately understand your company's products and services.

Second month: Gain agreement on what a strategic price is

·  For every new technology-based idea, push the technology staff to identify all of the alternatives from the buyer's point of view—not the competition's.

·  Have the technology staff identify which alternatives capture the greatest mass of buyers and at what price. Be careful not to overdeliver on what buyers actually value.

·  Remind them that the objective is to set a strategic price that can pull in all of these customers.

Third month: Set aggressive target costs for employees

·  Set price-minus, not cost-plus, targets for delivering on new business ideas.

·  Let employees know that cost overruns won't be permitted.

·  Encourage employees to apply their best thinking to hit the target cost.

·  Then let the employees go forward with their assigned tasks.

W. Chan Kim is The Boston Consulting Group Bruce D. Henderson Chaired

Professor of International Management and
Professor of Strategy and International Management at INSEAD.

Renée Mauborgne is The INSEAD Distinguished Fellow and

Professor of Strategy and Management at INSEAD. 

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