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

Chief Executive, The, March, 2005 by W. Chan Kim, Renee Mauborgne

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.