Breaking the Value vs Cost Trade-Off with Blue Ocean Strategy

When considering purchasing a car, do you prefer a cheap car that reliably gets you from A to B but lacks any bells and whistles, or a more expensive car that comes with all the luxury items you would expect for the higher price tag? This dilemma embodies the game of business: a trade-off between the value provided to the customer and the cost of the offering.

Ultimately, this choice is up to you. Each car manufacturer has chosen their position in a crowded market. However, what if there was a better way for manufacturers to provide more value to their customers while keeping the price low?

The Value vs Cost Trade-Off

If you have studied business, you have likely heard of competitive advantage, and what you learned about it was probably based, at least in part, on the work of Michael Porter. In 1985, he wrote “Competitive Advantage: Creating and Sustaining Superior Performance,” in which he outlined three ways a company can gain an advantage over its rivals:

1. Cost leadership — A company gains an edge over competitors by reducing its costs and either (a) maintaining going-rate pricing (charging the same price as the competition) while increasing its profit margin, or (b) taking a price leadership position and charging less than its competitors while still maintaining a reasonable profit.
2. Differentiation — A company competes by offering a better or more attractive product than its rivals. It can then charge a higher price that reflects the increased value it provides to customers. However, offering a better product often costs more in terms of research and development, manufacturing, marketing, and so on. Despite the higher price, the costs are also higher.
3. Focus — A company targets specific market segments or niches. This requires a deep understanding of market dynamics and customers’ unique needs. However, it also means that the company is only targeting a small portion of the overall market.

Michael Porter described competition as being focused on rivals and finding ways to outperform them. By offering a cheaper product, offering something different and better, or targeting a specific niche, a company can gain an advantage.

In their book “Blue Ocean Strategy,” W. Chan Kim and Renée Mauborgne liken this kind of competition to a red ocean, where sharks attack each other. In this analogy, the ocean represents the industry as it exists today, and the sharks represent competitors in that industry.

The goal of business is to beat the competition. A budget car brand gains market share by selling a cheaper car than others, whereas a luxury car brand can sell its car for a higher price because it provides more value, at least in terms of perceived value, to its customers.

In this game, each brand focuses on what the other brands are offering, positions itself accordingly, and then tries to beat the competition. Hence, the blood in the red ocean.

Blue Ocean Strategy

What if, instead of focusing on what the other players in the industry are doing, a company focused internally and exploited its capabilities? Every company has unique internal resources and capabilities, both tangible and intangible. These may include size, distribution network, innovation (or unique intellectual property), environment, access to technology, human resources, and more.

By analyzing its internal resources and capabilities, a company can identify at least one advantage that its competitors do not have and will struggle to imitate.

In 1908, there were 500 automakers in the USA, including Ford. These automakers employed skilled workers who made each car by hand. The cars were small, unattractive, unreliable, and expensive, costing about twice the annual household income. As a result, the market was small, and owning a car was a massive luxury.

Ford’s internal capability that set it apart from other automakers was an innovation: the assembly line. By focusing internally rather than on the competition, Ford could exploit the ingenuity of its people and innovate the manufacturing workflow. As a result, Ford could offer a more reliable and less expensive car than anyone else and broke the value vs. cost trade-off.

At the time, their sales slogan was simple and communicated this perfectly: “Watch the Ford Go By, High Priced Quality in a Low Priced Car.”

Breaking the value vs. cost trade-off paid off immensely for Ford as they could access new customers who previously could never have even thought of buying a car. Their first Model T sold for $850, about half the cost of existing cars. From 1908 to the early 1920s, Ford increased its market share from 9% to more than 60%, reducing labour costs by 60%. These economies of scale and reduced costs allowed Ford to cut the price of their cars down to $240 in 1921.

Ford was able to escape the “red ocean” and move into the “blue ocean.” By aligning all of its activities to pursue differentiation at a low cost, Ford only sold a couple of models, but these had interchangeable parts, were reliable, easy to fix, and cheaper than the competition. The competition was irrelevant for any customer who could not afford another, more expensive car. This meant Ford could create and capture new demand, new customers who previously couldn’t afford a car and couldn’t afford any of the competition’s offerings.

By breaking the value vs. cost trade-off, Ford was able to create and capture uncontested market space.

Blue Ocean Strategy is about pursuing differentiation and low cost at the same time. Doing this opens up new market space and allows a company to target customers that previously weren’t even in the market. It is about redefining the boundaries of the market and changing the industry structure, thereby creating and capturing uncontested market space while making the competition irrelevant.

Six Places to Use Blue Ocean Strategy

Wondering how to apply the Blue Ocean Strategy to your business? There are countless possibilities, but identifying potentially profitable blue oceans in the following six areas is a good start.

1. Industry — In a red ocean, competitors focus on each other and rarely explore alternative industries to see how they can provide value there. Companies don’t just compete with players in their industry but also with industries that offer substitute or alternate offerings. To create a new market space, a company can capture market share in multiple industries by analyzing what factors lead customers to alternate industries.
2. Strategic Group — Within each industry, groups of companies have a similar business model; they capture value using a similar strategy. Instead of trying to improve the current business model, look across different strategic groups and ask why customers choose to trade up or down. Constructing a Strategy Canvas is a quick method to visualize how this works.
3. Buyer Group — To target new customer groups, stop trying to capture more market share. Any one industry is currently targeting only a small subset of the population. Look at non-customers; what are the wants and needs of people who are currently unaware or uninterested in your industry and offerings? Don’t just target your offerings at current customers and aim to serve them better; serve people in one of the three tiers of non-customers.
4. Scope of Offering — Instead of focusing on maximizing the value of the current offering, provide new utility to your customers. Incorporate a new utility that makes it simpler, more convenient, quicker, better for the environment, or more fun than your competitors. Using a Buyer Utility Map can help to identify how to add new utilities at different stages of the buyer’s experience cycle.
5. Functional-Emotional Orientation — After redefining the scope of the offering, rethinking the functional-emotional orientation of the industry can unlock new demand. If the industry is function-focused, shifting to incorporate an emotional utility can have a considerable impact. By using the emotional appeal of eating healthier, Subway created new demand in the fast-food industry that typically competes on price and convenience.
6. Timeshift from reactive to proactive; be the one that rocks the boat. Gain insight into how trends will change the value to the customer and the business model in the future. A company can open up unprecedented customer utility by understanding what and how specific trends will affect the future and acting decisively to capitalize on these.

When beginning strategy formulation, consider how you can break the value vs cost trade-off in these six areas. This will undoubtedly lead to more creative ideas and perspectives. Breaking down some common assumptions about the game of business will lead to new insights about your organization and industry, and this is where innovations and opportunities come from.

For more information about Blue Ocean Strategy, please look at the book and the website.