Sunday, February 19, 2006

What Color is Your Ocean?

This semester I’m teaching Competitive Environment and Strategy to 37 MBA candidates at Babson College -- which US News and World Report ranked #1 for entrepreneurship for the tenth year in a row. A few weeks ago, one of my students asked me whether I had heard of Blue Ocean Strategy (BOS). A couple of days later, an executive at another company asked me to propose how I could help the company implement BOS.

Now I am asking myself “Could BOS be the next management fad?” To explore this question, I’ll address some others:

  • What is BOS?
  • Why does it interest managers?
  • What are BOS’s strengths and weaknesses?
  • How can it be implemented?

BOS is an idea described in a book of the same name by two professors at INSEAD. According to the professors, most companies participate in red oceans – highly competitive markets in which it is difficult to earn good profits because companies benchmark each others’ performance and ultimately end up with the same strategies – many of which involve intense price competition. By contrast, a few companies have created blue oceans – entirely new industries whose creators enjoy profitable growth with no competition due to the unique value they provide to a large swath of previously underserved customers.

To bolster their case, the authors cite their study of 108 companies’ business launches. 86% of the launches were incremental improvements within red oceans; whereas 14% were aimed at creating blue ones. While the red ocean line extensions delivered 62% of the total revenues, they only produced 39% of the total profits. By contrast, the BOSs generated a mere 14% of the revenues but a whopping 61% of the total profits.

The authors cite Casella Wines, an Australian winery whose new product sold 11.2 million cases in the US two years after it was introduced, as an example of BOS’s benefits. With its fun, easy-to-enjoy, everyday wine, Casella Wines’ BOS captured consumers of beer, spirits, and ready-to-drink cocktails – alcohol markets which are three times larger than the US wine industry. By looking to these wine alternatives, Casella learned that most Americans viewed wine as intimidating and pretentious and that wine’s complex taste – a dimension along which winemakers competed -- made it difficult for most Americans to drink regularly.

Using this insight, Casella introduced [yellow tail] in 2002, a brand which by August 2003 was the top selling US red wine. Casella’s BOS made [yellow tail] social and accessible to drinkers of beer and other wine alternatives. [yellow tail] tasted fruity and sweet, rather than complex, and the brand consisted of only two wines – a white Chardonnay and a red Shiraz -- whose packaging was simple and eye-catching. Moreover, Casella gave Australian outback clothing to retail employees which inspired them to recommend [yellow tail] to customers.

Meanwhile Casella chose not to perform activities which other wine companies viewed as essential. For example, [yellow tail] was not aged so Casella did not require the working capital associated with storing wine in wooden barrels for long periods of time. Furthermore, unlike its wine industry competitors, Casella chose not to spend money on promotional campaigns, mass media, or consumer advertising. In addition, since it only had two kinds of wine, it had higher stock turnover and minimal investment in warehouses and inventory.

My theory on why BOS interests managers is simple. After years of cutting costs since the economic contraction which began in 2001, many companies have realized that future earnings growth will need to come from revenue increases. And since many managers these days are risk averse, they would prefer to invest in growth opportunities which they perceive as having the greatest profit potential. BOS seems to answer that managerial call -- offering the promise of highly profitable revenue growth. And as the Casella Wine case suggests, BOS’s payback can happen very fast.

However, to gain widespread adoption, established companies will need to find a way to profit from BOS. This may not be so easy because many established companies have a very difficult time changing the way they think about their businesses. Moreover, this resistance to change is not simply a matter of psychology – it is also a result of managers’ incentives which are often based on exceeding quarterly profit targets. But implementing BOS can involve a radical change in business strategy which may undermine existing strategy – hence requiring a big investment with a payoff which managers may perceive as uncertain and of indeterminate size. Managers will be reluctant to take such risks unless senior executives give more than a lip service commitment to supporting them.

Since BOS is a new management concept, it has not been widely adopted by large corporations – and it may never be. Many large corporations will wait to see whether BOS enables their more adventurous peers to achieve measurable and dramatic success. If so, large companies may feel compelled to remedy their BOS envy by adopting it aggressively. Veterans of previous management fads will need to see whether management is sufficiently committed to BOS to alter corporate incentives and investment criteria in order to capture BOS’s potential payoff.

In my view, companies that decide to move forward with BOS should take the following six steps:

  • Build the BOS Team. Establish a project team and a steering committee of senior executives that reviews the work of the project team to assure that its recommendations will be implemented. This first step results in agreement on objectives, methodology, and business scope. And it trains the team members in the BOS tools they will need to conduct the project;
  • Develop a strategy canvas for the selected business. A strategy canvas maps how an industry’s providers perform on key competitive factors from the customer’s perspective. For example, the strategy canvas for the wine industry illustrates how well wineries’ perform in terms of criteria such as price, use of wine industry terminology in marketing, aging, quality, and vineyard prestige. For a company implementing BOS, this step would identify these key competitive factors and map out how customers perceive that the company and its competitors perform vis-à-vis these factors;
  • Evaluate the alternatives to the selected business. Alternatives are the different products that customers may buy instead of the ones that the company sells. By analyzing the key competitive factors in these alternative industries, a company can identify blue oceans by imagining a new positioning that draws in customers from the alternative products. Casella’s analysis of the key competitive factors in alternative industries – such as beer and spirits – revealed that many of these beer and spirits customers were put off by wine’s complex taste and its snobby positioning. As with Casella, this step is intended to provide the basis for a company to identify the unique positioning that will drive its BOS;
  • Define the company’s BOS. Using the Four Actions Framework (FAF), this phase defines a company’s BOS. The FAF leads a company to identify (1) which industry factors it can eliminate, (2) which ones it can reduce, (3) which new sources of buyer value it should create, and (4) which existing industry factors it should raise. For example, Casella’s [yellow tail] eliminated wine terminology in marketing and the wine industry’s focus on aging and quality; it reduced vineyard prestige and wine complexity; it created easy drinking, ease of selection, and fun and adventure; and it raised price. In this phase, a company defines a memorable tag line for its BOS, and makes specific choices regarding target customers, product/service positioning vis-à-vis key customer purchase criteria, and functional policies in activities such as manufacturing, marketing, distribution, and research;
  • Perform a BOS financial evaluation. This phase estimates the BOS’s future cash flows. It develops a base case scenario and identifies the assumptions that lead to the biggest variations in the BOS’s base case net present value. It also provides a company with optimistic and pessimistic scenarios which help the steering committee decide on the magnitude and timing of the capital and managerial investments required to implement the BOS; and
  • Plan the BOS’s implementation. In this final phase, the project team develops a sequence of strategic initiatives that will be required to implement the BOS. For each strategic initiative, the project team defines the key action steps, accountable manager(s), deliverables, deadlines, and additional resources required.

If it helps companies grow more profitably, then BOS deserves to be the next management fad. Your company should decide whether it wants to be among the first to find out.


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