Blue Ocean Strategy

The strategic logic employed by creators of blue oceans is called value innovation. Instead of focusing on beating the competition, W. Chan Kim and Renee Mauborgne (2005) suggested that we should focus on creating a “huge leap” in value (by using the six principles of Blue Ocean Strategy) for both buyers and our company (which is hard to be imitated by competitors). With this, we will be able to open up a new and uncontested market space, which rules are waited for us to be set. The new uncontestable market will make the competition from other firms irrelevant as the other competitors are still competing within the old market boundaries. When competition is irrelevant, value innovation enable us to pursue both low cost and differentiation strategy simultaneously. As shown in Figure 1 below, Value Innovation, as the cornerstone of Blue Ocean Strategy, is created in the region where a company’s actions favorably affect both its cost structure and its value proposition to buyers.

Figure 1: Value Innovation as the Cornerstone of Blue Ocean Strategy.

From Diminishing Returns to Increasing Returns

Until late 90s, there is an understanding based on the assumption of diminishing returns: where products or companies that get ahead in a market will eventually run into limitations, until a predictable equilibrium of prices and market shares is reached. However, steadily and continuously in this century, the world economies (particularly the Western countries) have undergone a knowledge-based economy transformation. As this shift has taken place, the underlying mechanisms that determine economic behavior have shifted from ones of diminishing to ones of increasing returns (Arthur, 1996).

In the context of Value Innovation, W. Chan Kim and Renee Mauborgne (2005) suggested that in a world of non-rival and non-excludable goods (such as knowledge and ideas), there are the potential of economies of scale, increasing accumulation of human capital from learning curve and thus increasing returns to the products or companies. This is the reason which causes the importance or volume, price, and cost grows in an unprecedented way (volume, price and cost concepts as the economic characteristics of Value Innovation will be discussed in the next section). Under the concept of increasing returns, companies would do well to capture the mass target buyers from the beginning and expand the size of the market by offering ‘radically superior value’ at price points accessible to them. In layman term, provide higher value with lower price; a focus on both differentiation (to be precise, a ‘high degree of differentiation’ which able to create a ‘huge leap’ in value and thus produce an uncontested market space) and low cost simultaneously.

The Economic Characteristic of Value Innovation

Successful Value Innovation will be able to produce a ‘huge leap’ in value and thus radically increases the appeal of a product. As shown in Figure 2, this will shift the demand curve from D1 to D2. Acoording to Blue Ocean Strategy, besides having a leap in value in the products, companies can be well done by lowering the product’s price further, to capture the mass of buyers in the expanded market. This means that the price is reduced from P1 to P2 in Figure 2 as shown below. As a result, the company that practice Value Innovation will be able to increases the quantity sold from Q1 to Q2, significantly creating new aggregate demand throuigh a leap in buyer value at an accessible price. This strategic move will enable the company to builds strong brand recognition, for un precedented value. Besides, the company should also enagegs in target costing to simultaneously reduce the long-run average cost curve from LRAC1 to LRAC2 to expand its ability to profit and to discourage free riding as well as imitation. In an increasing return context, as the company (as the first mover) able to reach the mass buyers, economies of scale is created. In a knowledge-based economy, knowledge and ideas (from accumulation of human capital through learning process), which is the key to innovation enable continuous improvement, thus lowering the long run average cost curve.

Figure 2: Market Dynamics of Value Innovation.

Source: Blue Ocean Strategy (Kim et al., 2005, pg214)

Hence, buyers receive a leap in value, shifting the consumer surplus from axb to eyf. And the company earns a leap in profit and growth, shifting the profit zone from abcd to efgh.

Ultimately, the rapid brand recognition built by the company as a result of the unprecedented value offered in the marketplace, combined with the simultaneos drive to lower costs, makes the competition nearly irrelevant and makes it hard to catch up, as economies of scale, learning and increasing returns kick in. The final results shall be the emergence of win-win market dynamics, where companies earn dominant positions while buyers also come out as big winners.

Save

Save