Creating a blue ocean of profit: CEOs should not merely compete in commoditized sectors. They must break free.

The American wine industry is worth $20 billion a year. Competition is fierce and dominated by a handful of key players. Add in stagnant demand and the picture hardly seems appealing, especially if you are a wine producer from outside the United States.

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Enter Yellow Tail, produced by Casella Wines in Australia. Yellow Tail is the fastest-growing foreign wine label in U.S. history. In less than three years, it has become the No. 1 imported wine in the U.S., selling more than 11.2 million cases in 2004.

How did Casella break away? It began by taking a different perspective on the wine market. It looked across the alternatives to wine: Beer, spirits and ready-to-drink cocktails capture more than three times as much in consumer sales as wine. Casella also discovered that most Americans actually found wine a turnoff. Wine was intimidating and pretentious, a highly acquired taste. While the wine industry long competed on how to make a sophisticated wine for special occasions, Casella redefined the challenge to: How do you make a fun, casy-to-enjoy wine for every day?

The answer was Yellow Tail. Gone were the intimidating labels, the discussions on tannins and oak. Endless choice was clipped to two varieties, one red and one white. The labels were simple and colorful, the taste sweet and fruity. With no promotional campaign, Yellow Tail rendered its competition irrelevant. It didn't simply steal market share; it grew the market, bringing in 6 million new wine drinkers. Novice wine drinkers began to drink more wine, jug-wine drinkers moved up market and expensive-wine drinkers moved down to Yellow Tail.

To understand Yellow Tail's success, imagine a market universe composed of two sorts of oceans--red and blue. Red oceans represent all of the industries in existence today, or known market space. Blue oceans denote industries not in existence today, or unknown market space. The objective is to create blue oceans.

The red ocean is crowded with players engaging in brutal competition. Companies try to outperform their rivals through incremental changes in price or quality. As the market space becomes more and more crowded, prospects for profit and growth are reduced. Products become commodities and cutthroat competition turns the ocean bloody, hence the term "red ocean."

The blue ocean, in contrast, is defined by untapped market space. Demand is created rather than fought over. There is ample opportunity for profitable and rapid growth. In blue oceans, competition is irrelevant because the rules of the game are waiting to be set.

Which ocean would you prefer your company to swim in?

Differentiation and Low Costs

Red-ocean strategy assumes an industry's structural conditions are given and that firms have to compete within a finite market space. To sustain themselves in the marketplace, practitioners focus on building advantages over the competition, usually by assessing what their competitors do and striving to do it better. Think of the traditional wineries with their ever-more complicated labels and exploding wine choices. Here, grabbing a bigger share of the market is seen as a zero-sum game. Competition becomes the defining variable of the strategy.

Such strategic thinking leads firms to classify industries as being either attractive or unattractive, and to decide accordingly whether or not to enter them. Once a firm has entered an industry, it chooses a distinctive cost or a differentiated position. Cost and value are seen as trade-offs. Because the total profit level of the industry is also determined by structural factors, firms principally seek to capture and redistribute wealth rather than to create wealth. They focus on dividing up the red ocean.

Under blue-ocean strategy, the strategic challenge looks very different. Recognizing that structure and market boundaries exist only in managers' minds, practitioners who hold this view see beyond existing market structures. To them, extra demand is out there, largely untapped. The challenge is how to create it. This requires a shift of attention from supply to demand, from a focus on competing to a focus on creating value that generates new demand. This is achieved via the simultaneous pursuit of differentiation and low cost.

A host of companies have successfully pursued blue-ocean strategies. Rather than being constrained by the structures and conditions of existing markets, companies like FedEx, eBay, Starbucks and Cirque du Soleil reinvented old industries, created new ones and generated new wealth. They moved from having customers to having fans. They didn't make the trade-off between value and costs; they broke it. Think of Starbucks, which has become an American icon in just 15 years, or FedEx, which is now both a company name and a verb. These companies created a win-win for everyone--customers, employees, shareholders and the company.

The commercial attractiveness of blue oceans is undeniable. We quantified the impact of creating blue oceans of new market space on a company's growth in both revenues and profits in a study of the launches of 108 companies. We found that 86 percent of the launches were merely line extensions. Yet, they accounted for only 62 percent of total revenues and a mere 39 percent of profits. The remaining 14 percent of the launches were aimed at creating new markets. These generated 38 percent of total revenues and a whopping 61 percent of profits.

Why is it urgent to launch blue-ocean strategies in today's environment? One reason is that technological advances have substantially improved productivity, permitting suppliers to produce an unprecedented array of goods and services. And as trade barriers between nations and regions fall, and information on products and prices becomes instantly and globally available, niche markets and monopoly havens are continuing to disappear. At the same time, there is little evidence of any increase in demand, at least in the developed markets.

For companies locked into the red ocean of bloody competition, supply is overtaking demand in more and more industries. This hastens the commoditization of products and services, stokes price wars and shrinks profit margins. According to recent studies, major American brands in a variety of product and service categories have become increasingly alike, leading consumers to base purchase choices on price. People no longer insist that their laundry detergent be Tide, nor do they necessarily stick to Colgate when there is a special promotion for Crest, and vice versa. In overcrowded industries, differentiating brands becomes harder in both economic upturns and downturns.

As a result, companies are driven to compete principally on cost. This, in turn, has helped spur the rising exodus of jobs to low cost countries like India and China. While governments may seek to solve the issue of outsourcing through legislation, history teaches us that this is not a long-term solution. The solution is for companies to create compelling products and services that take them out of the vicious cycle of commodity competition. These issues make blue-ocean strategy a rising imperative for CEOs.

How To Reach Uncharted Waters 

Even if CEOs and strategists accept our arguments, the big question remains: How can companies successfully create blue oceans?

Based on our decade-long research, spanning more than 30 industries and stretching back 100 years, we found systematic patterns in the creation of blue oceans. Here are a some key highlights:

First, blue oceans are not created by benchmarking the competition. That only makes companies similar to their competitors, and stuck in a red ocean. Instead, companies need to reconstruct market boundaries to break away from rivals. Consider how Cirque du Soleil offers the best of both circus and theater. It has eliminated or reduced everything else.

By offering unprecedented utility, Cirque du Soleil has invented a new form of live entertainment, one markedly different from both traditional circus and theater. At the same time, by eliminating many of the most costly elements of a circus, including animals, it has dramatically reduced its cost structure, breaking the trade-off between differentiation and low cost. Cirque strategically priced its tickets against those of theater, lifting the price point of the circus industry by several multiples while still being priced to capture a mass adult market.

Second, companies should focus on the big picture, not the numbers. In our book, we introduce a tool called a strategy canvas, which depicts the strategic profile of an industry by showing the factors that affect competition among industry players; the strategic profile of current and potential competitors; and a company's own strategic profile. The aim is to produce a strategic profile that diverges from the competition, has focus--hence, lower costs--and a compelling tagline that speaks to the market. Divergence, focus and a compelling tagline were found to be the three defining characteristics of an effective blue-ocean strategy.

Third, companies should reach beyond existing customers. They should look to noncustomers. Consider Callaway Golf. It generated new demand by attracting noncustomers. Looking at alternative country club sports, Callaway found that tennis was the largest draw to new players. Golf lagged behind because the golf ball was viewed as too hard to hit due to the small head of a golf club. People regarded the game as too difficult to make progress in and tended to lose interest. This insight led to the launch of the Big Bertha in 1991. The club had a larger head, making it much easier to hit the ball. This innovation carried Callaway to the top of its market. Even people who had never played golf were attracted to the game.

Fourth, to build a robust business model to profit from blue-ocean ideas, executives need to get the strategic sequence right. In 1998 Motorola rolled out a product called Iridium to redefine mobile telephony. Iridium, the company declared, would be the first mobile phone to provide uninterrupted wireless communication anywhere in the world. The revolutionary system, based on a $5 billion network of 66 low-orbiting satellites, was expected to attract at least 32 million subscribers. Iridium needed 1 million subscribers to break even, but buyers never arrived. A mere 15,000 people signed up. Iridium was a commercial failure on a grand scale.

Motorola managers, and their counterparts throughout the world, are concerned about creating situations in which they win. Yet, to achieve sustained profitable growth and create new blue oceans, companies cannot start by simply considering how they might win. Without first creating winning opportunities for buyers, companies cannot win themselves. But as Motorola's travails show, even the most admired companies can forget common sense and get the sequence of strategy spectacularly wrong.

This article was excerpted, with permission, from Blue Ocean Strategy: How to Create Uncontested Market Space and Make the Competition Irrelevant (Harvard Business School Press, 2005), by INSEAD professors W. Chan Kim and Renee Mauborgne.

RELATED ARTICLE: A Checklist For Creating New Markets

1 Don't just bench-mark the competition. This only serves to make a company similar to its rivals. Invent new forms of products and services to draw customers beyond those in the existing market.

Example: Cirque du Soleil's marketing to adults

2 Focus on the big picture, not the numbers. Create a strategic profile that diverges from that of the competition, is more focused (hence, lower cost) and has a compelling tagline.

Example: Casella Wine's launch of Yellow Tail, an unpretentious wine label

3 Reach beyond existing customers. Look to noncustomers, and innovate in such a way that they'll become drawn to your market.

Example: Callaway Golf's debut of Big Bertha, an easy-to-hit golf club

4 Get your strategic sequence right. Don't start by considering only how you might win. Be sure to create winning opportunities for your customers first.

Example: Motorola's failure to secure a market for Iridium, its plan to provide uninterrupted worldwide cell-phone service