February 11, 2005
Blue Ocean Strategy - Part VI
By probing questions such as these, the Swiss watch company Swatch, for example, was able to arrive at a cost structure some 30 percent lower than any other watch company in the world. At the start, Nicolas Hayek, chairman of Swatch, set up a project team to determine the strategic price for the Swatch. At the time, cheap (about $75), high-precision quartz watches from Japan and Hong Kong were capturing the mass market. Swatch set the price at $40, a price at which people could buy multiple Swatches as fashion accessories. The low price left no profit margin for Japanese or Hong Kong-based companies to copy Swatch and undercut its price. Directed to sell the Swatch for that price and not a penny more, the Swatch project team worked backwards to arrive at the target cost, a process that involved determining the margin Swatch needed to support marketing and services and earn a profit.
Given the high cost of Swiss labor, Swatch was able to achieve this goal only by making radical changes in the product and production methods. Instead of using the more traditional metal or leather, for example, Swatch used plastic. Swatch’s engineers also drastically simplified the design of the watch’s inner workings, reducing the number of parts from one hundred fifty to fifty-one. Finally, the engineers developed new and cheaper assembly techniques; for example, the watch cases were sealed by ultrasonic welding instead of screws. Taken together, the design and manufacturing changes enabled Swatch to reduce direct labor costs from 30 percent to less than 10 percent of total costs. These cost innovations produced a cost structure that is hard to beat and let Swatch profitably dominate the mass market for watches, a market previously dominated by Asian manufacturers with a cheaper labor pool.
February 10, 2005
Blue Ocean Strategy - Part V
Targeting Costing
Target costing, the next step in the strategic sequence, addresses the profit side of the business model. To maximize the profit potential of a blue ocean idea, a company should start with the strategic price and then deduct its desired profit margin from the price to arrive at the target cost. Here, price-minus costing, and not cost-plus pricing, is essential if you are to arrive at a cost structure that is both profitable and hard for potential followers to match.
When target costing is driven by strategic pricing, however, it is usually aggressive. Part of the challenge of meeting the target cost is addressed in building a strategic profile that has not only divergence but also focus, which makes a company strip out costs. Think of the cost reductions Cirque du Soleil enjoyed by eliminating animals and stars or that Ford enjoyed by making the Model T in one color and one model having few options.
Sometimes these reductions are sufficient to hit the cost target, but often they are not. Consider the cost innovations that Ford had to introduce to meet its aggressive target cost for the Model T. Ford had to scrap the standard manufacturing system, in which cars were handmade by skilled craftsmen from start to finish.
Instead, Ford introduced the assembly line, which replaced skilled craftsmen with ordinary unskilled laborers, who worked one small task faster and more efficiently, cutting the time to make a Model T from twenty-one days to four days and cutting labor hours by 60 percent.3 Had Ford not introduced these cost innovations, it could not have met its strategic price profitably. Instead of drilling down and finding ways to creatively meet the target cost as Ford did, if companies give in to the tempting route of either bumping up the strategic price or cutting back on utility, they are not on the path to lucrative blue waters. To hit the cost target, companies have three principal levers.
The first involves streamlining operations and introducing cost innovations from manufacturing to distribution. Can the product’s or service’s raw materials be replaced by unconventional, less expensive ones—such as switching from metal to plastic or shifting a call center from the U.K. to Bangalore? Can high-cost, low-valueadded activities in your value chain be significantly eliminated, reduced, or outsourced? Can the physical location of your product or service be shifted from prime real estate locations to lower-cost locations, as The Home Depot, IKEA, and Wal-Mart have done in retail or Southwest Airlines has done by shifting from major to secondary airports? Can you truncate the number of parts or steps used in production by shifting the way things are made, as Ford did by introducing the assembly line? Can you digitize activities to reduce costs?
February 9, 2005
Blue Ocean Strategy - Part IV
Step 2: Specify a Level Within the Price Corridor
The second part of the tool helps managers determine how high a price they can afford to set within the corridor without inviting competition from imitation products or services. That assessment depends on two principal factors. First is the degree to which the product or service is protected legally through patents or copyrights. Second is the degree to which the company owns some exclusive asset or core capability, such as an expensive production plant, that can block imitation. Dyson, a British electrical white goods company, for example, has been able to charge a high unit price for its bagless vacuum cleaner since the product’s launch in 1995, thanks to both strong patents and hard-to-imitate service capabilities.
Many other companies have used upper-boundary strategic pricing to attract the mass of target buyers. Examples include DuPont with its Lycra brand in specialty chemicals, Philips’ ALTO in the professional lighting industry, SAP in the business application software industry, and Bloomberg in the financial software industry.
On the other hand, companies with uncertain patent and asset protection should consider pricing somewhere in the middle of the corridor. As for companies that have no such protection, they must set a relatively low price. In the case of Southwest Airlines, because its service wasn’t patentable and required no exclusive assets, its ticket prices fell into the lower boundary of the corridor—namely, against the price of car travel. Companies would be wise to pursue mid- to lower-boundary strategic pricing from the start ifany ofthe following apply:
- Their blue ocean offering has high fixed costs and marginal variable costs.
- Their attractiveness depends heavily on network externalities.
- Their cost structure benefits from steep economies of scale and scope. In these cases, volume brings with it significant cost advantages, something that makes pricing for volume even more key.
The price corridor of the mass not only signals the strategic pricing zone central to pulling in an ocean of new demand but also signals how you might need to adjust your initial price estimates to achieve this. When your offering passes the test of strategic pricing, you’re ready to move to the next step.
February 8, 2005
Blue Ocean Strategy - Part III
Different form and function, same objective. Some companies lure customers from even further away. Cirque du Soleil, for example, has diverted customers from a wide range of evening activities. Its growth came in part through drawing people away from other activities that differed in both form and function. For example, bars and restaurants have few physical features in common with a circus. They also serve a distinct function by providing conversational and gastronomical pleasure, a very different experience from the visual entertainment that a circus offers. Yet despite these differences in form and function, people have the same objective in undertaking these three activities: to enjoy a night out.
Listing the groups of alternative products and services allows managers to see the full range of buyers they can poach from other industries as well as from nonindustries, such as parents (for the school lunch catering industry) or the noble pencil in managing household finances (for the personal finance software industry). Having done this, managers should then graphically plot the price and volume of these alternatives.
This approach provides a straightforward way to identify where the mass of target buyers is and what prices these buyers are prepared to pay for the products and services they currently use. The price bandwidth that captures the largest groups oftarget buyers is the price corridor of the mass.
In some cases, the range is very wide. For Southwest Airlines, for example, the price corridor of the mass covered the group of people paying, on average, $400 to buy an economy-class short-haul ticket to about $60 for the cost of going the same distance by car. The key here is not to pursue pricing against the competition within an industry but rather to pursue pricing against substitutes and alternatives across industries and nonindustries. Had Ford, for example, priced its Model T against other autos, which were more than three times the price of horse-drawn carriages, the market for the Model T would not have exploded.
February 7, 2005
Blue Ocean Strategy - Part II
Strategic Pricing
We have developed a tool called the price corridor of the mass to help managers find the right price for an irresistible offer, which, by the way, isn’t necessarily the lower price. The tool involves two distinct but interrelated steps.
Step 1: Identify the Price Corridor of the Mass
In setting a price, all companies look first at the products and services that most closely resemble their idea in terms of form. Typically they look at other products and services within their industries. That’s still a necessary exercise, of course, but it is not sufficient to attract new customers. So the main challenge in determining a strategic price is to understand the price sensitivities of those people who will be comparing the new product or service with a host of very different-looking products and services offered outside the group of traditional competitors.
A good way to look outside industry boundaries is to list products and services that fall into two categories: those that take different forms but perform the same function, and those that take different forms and functions but share the same over-arching objective.
Different form, same function. Many companies that create blue oceans attract customers from other industries who use a product or service that performs the same function or bears the same core utility as the new one but takes a very different physical form. In the case of Ford’s Model T, Ford looked to the horse-drawn carriage. The horse-drawn carriage had the same core utility as the car: transportation for individuals and families. But it had a very different form: a live animal versus a machine. Ford effectively converted the majority of noncustomers of the auto industry, namely customers of horse-drawn carriages, into customers of its own blue ocean by pricing its Model T against horse-drawn carriages and not the cars of other automakers.
In the case of the school lunch catering industry, raising this question led to an interesting insight. Suddenly those parents who make their children’s lunches came into the equation. For many children, parents had the same function: making their child’s lunch. But they had a very different form: mom or dad versus a lunch line in the cafeteria.
Blue Ocean Strategy - Part I
Blue Ocean Strategy: How To Create Uncontested Market Space And Make The Competition Irrelevant
by W. Chan Kim and Renee Mauborgne
Harvard Business School Press - February 2005
288 Pages - ISBN 1591396190
I chose a section from Chapter 6 called "Get The Strategic Sequence Right". Kim and Mauborgne say that companies need to build their blue ocean strategies "in the sequence of buyer utility, price, cost, and adoption". We have enough room to cover the price and cost part of the sequence.