Breaking the Value vs Cost Trade-Off with Blue Ocean Strategy
When you’re thinking about buying a car, which do you prefer: a cheap car that will reliably get you from A to B, but doesn’t come with any ‘bells and whistles’, or a more expensive car that comes with all of the luxury items that you’d expect with the higher price tag? This is the game of business: a trade-off between the value you are providing to the customer and the cost of the offering.
This choice is, of course, up to you. Each car manufacturer has chosen their position in a crowded market.
But what if there was a better way, a way that allowed a manufacturer to provide more value to the customer whilst keeping the price low?
- Traditionally the game of business has been a trade-off between cost and value, with a focus on beating the competition.
- By focussing on internal capabilities, instead of what competitors are doing, a company can move beyond the red ocean, it can create sustainable competitive advantage and their own blue ocean.
- By breaking the cost vs value trade-off, companies can create uncontested market space and access customers that previously weren’t even in the market.
The Value vs Cost Trade-Off
If you’ve studied in the Business field, you’ve probably heard of competitive advantage, and what you were taught about competitive advantage was almost certainly based, to some extent, 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 a competitive advantage over its rivals.
- Cost Leadership — The edge a company has over its competitors is its cost. It reduces its costs and either (a) maintains going-rate pricing (the price to the customer is the same as the competition) and increases its profit margin, or (b) it takes a price leadership position, competes on price (charges less to the customer than its competitors) and takes more market share while still maintaining a reasonable profit.
- Differentiation — The company competes by having a better or more attractive offering than its competitors. It can then charge a higher price that reflects the increased value they are providing to the customer. The issue is that when they have a better offering, it usually costs more; whether that be R&D, manufacturing, marketing, etc. Even though the price is higher, the costs are also higher.
- Focus — Focusing is where the company targets specific segments, or niches, of the market. This requires a deep understanding of the dynamics of the market and the unique needs of the customers. But, it is inherent that you are only targeting a small segment of the larger market.
Michael Porter described the competition as being focussed on their competitors and capitalising on ways that you can outperform them. By offering a product that is cheaper than others on the market, by offering something different and better or by targeting the needs of a specific niche.
In their book Blue Ocean Strategy, Chan Kim and Renée Mauborgne, have said that this kind of competition is like competing in a red ocean, an ocean of sharks that are attacking each other. In this analogy, the ocean is the industry as it exists today, and the sharks are the competitors in that industry.
The game of business is to beat your competitor. A budget car brand gets market share by selling a car that is cheaper than others, whereas a luxury car brand can sell their car for a higher price because they are providing more value — at least more perceived value — to their customers.
In this game, each brand is focussing on what the other brands are offering, positioning themself accordingly and then trying to beat them; hence the blood in the red ocean.
Blue Ocean Strategy
What if, instead of focussing on what the other players in the industry are doing, a company focusses internally and exploits its own capabilities. Each, and every, company has differing internal resources and capabilities; both tangible and intangible. This may be its size, distribution network, innovation (or unique intellectual property), environment, access to technology, human resources, etc.
If a company analyses its internal resources and capabilities, they would surely find at least one that their competitors don’t have and will struggle to imitate.
In 1908 there were five-hundred automakers in the U.S.A., one of which was Ford. These automakers employed skilled workers who made each car by hand. The cars were small, unattractive, unreliable and expensive — costing about two times the annual household income. For this reason, the market was quite small; owning an automobile was a massive luxury.
The internal capability that Ford had, that the other automakers did not, was innovation. That innovation was the assembly line. By focussing internally, not on the competition, Ford was able to exploit the ingenuity that its people had and innovate the manufacturing workflow. Ford could offer a more reliable and less expensive car than anyone else. They 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 were able to access new customers that, 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%, and they reduced labour costs by 60%. This 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 their own blue ocean. Ford aligned all of its activities to pursue differentiation at a low cost. They only sold a couple of models, but these had interchangeable parts, were reliable, easy to fix and cheaper than the competition. For any customer that could not afford another, more expensive car, the competition was irrelevant. This meant Ford was able to create and capture new demand; new customers that previously couldn’t have afforded a car, and currently 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
Okay, so, where do you start to apply Blue Ocean Strategy to your business? There is an almost infinite amount of possibilities to choose from, the following six areas will help to identify potentially profitable blue oceans.
- Industry — in a red ocean competitors focus on each other, rarely does a player look at an alternative industry and analyse how they can provide value there. Companies don’t just compete with players in their own industry, but industries that offer substitute or alternate offerings. For example, Netflix doesn’t just compete with other streaming services, TV shows and movies, what Netflix’s customers want is to relax and be entertained. In reality, Netflix is competing with libraries, shopping mall, recreation centres because all of these provide customers with the same utility that Netflix does. If a company can capture market share in multiple industries by looking at what factors lead customers to alternate industries they have created a new market space.
- Strategic Group — within each industry there are groups of companies that have a similar business model, they capture value using a similar strategy. Instead of trying to make the current business model better, instead, look across different strategic groups and ask why customers choose to trade up or down. A quick method to visualise how this works is to construct a Strategy Canvas.
- Buyer Group — instead of trying to capture more market share, start looking at how to target new customer groups. Only a small subset of the population is currently being targeted by any one industry. Look at non-customers, what are the wants and needs of the people that are currently unaware or uninterested in your industry and your offerings. Don’t just target your offerings at current customers and aiming to serve them better, serve people that are in one of the three tiers of non-customers.
- Scope of Offering — stop focussing on maximising the value of the current offering, instead look to provide new utility to your customers. If your current offering focusses on customer productivity, instead of innovating to make the offering do that better, look to incorporate a new utility. Make 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 utility at different stages of the buyer’s experience cycle.
- Functional-Emotional Orientation — following on from redefining the scope of the offering, rethinking the functional-emotional orientation of the industry can unlock new demand. If the industry currently is function focussed, shifting to incorporate an emotional utility can have a huge impact. The fast-food industry typically competes on the functions of price and convenience, by using the emotional appeal of eating healthier, Subway was able to create new demand.
- Time — shift from being reactive to proactive, be the one that rocks the boat. Action should be taken to gain an insight into how trends will change the value to the customer and the business model in the future. By understanding what and how certain trends will affect the future, and acting decisively to capitalise on these a company can open up unprecedented customer utility.
When beginning strategy formulation, consider how you can break the value vs cost trade-off in these six areas. This will surely lead to more creative ideas and perspectives. Breaking down some common assumptions about the game of business will lead to new insights about your organisation and industry. This is where new innovations and opportunities come from.