Blue ocean strategy

Blue Ocean Strategy

• Blue Ocean Strategy (2004) by W Chan Kim and Renee Mauborgne
• Basic metaphor is the creation of blue oceans which are uncontested
business spaces where the competition is irrelevant.
• This is in contrast to a red ocean which is the currently defined
industry space with fierce competition.
• In contrast to the Porter model ,Blue Ocean Strategy argues that you
should try to combine low cost and differentiation.
Red Ocean and Blue Ocean
Red Ocean
Competes in existing markets
Beat the competition
Exploit existing demand
Make the value-cost trade-off
Low Cost OR Differentiation
Blue Ocean
Creates uncontested markets
Make the competition irrelevant
Create new demand
Break the value-cost trade-off
Low Cost AND Differentiation
Value Cost Trade-off

BOS Diff

Value

CL

Cost
Changing the product mix
• Blue ocean strategy works by changing the mix of attributes that
defines a product, tailoring it for the new customers rather than the
old ones.
• Attributes that are high-cost and low value for the new customers are
dropped or reduced.
• Attributes that are low-cost and high value for the new customers are
added or increased.
• This is how low cost and differentiation are simultaneously achieved.
• E.g. Nintendo Wii, Cirque du Soleil
Nintendo Wii
• Launched in 2006. Coming after a relative failure for Nintendo, the
Gamecube which was well behind the Playstation 2.
• With the Wii Nintendo tried to target a new audience: non-gamers
including the elderly, very young children etc.
• They dropped features of less interest to this group like high-end
graphics which helped to keep costs low.
• At the same time they added features like motion-controls and
simple, fun fitness games which appealed to these new customers.
• The Wii was highly successful and for a number of years the leading
console in its generation.
Project guidelines
• Porter analysis of industry
• Analyze the five forces. Classify the threat level from each force: low,
medium, high and discuss implications.
• Recommend strategies for the company to deal with the major threats.
• Co-opetition:
• Draw the value net for the company like with the NES.
• Focus on the complementors and list as many as possible (at least 10)
• Identify strategies for the company to enhance the value net and increase
its added value. You may focus on 2-3 complementors and how your
company can work with them to increase sales.
Guidelines
Core competence:
Identify 1-2 key core competences using the three-fold criteria.
Recommend diversification strategies based on the core competencies
like with Casio,Canon etc.
You can also identify 1-2 key resources using the VRIO framework.
Blue Ocean Strategy:
Recommend one blue ocean strategy for the company. It should target
new customers and simultaneously pursue low cost and differentiation.
Co-opetition
Co-opetition
• Co-opetition by Adam Brandenburger and Barry Nalebuff written in
1996.
• Aims to apply core game theory principles to business strategy
• Basic concept of “co-opetition” is a combination of co-operation and
competition.
• Key insight that the relationship of companies with their different
stakeholders is often both co-operative and competitive. E.g.
company works its suppliers to improve design and technology while
still trying to keep prices low.
Value net

Customers

Competitors Company Complementors

Suppliers
Complementors
• A complementor makes the company’s product more attractive.
• Understanding the importance of complementors is crucial to
building a successful business especially a new one.
• E.g. Hardware and software, electric cars and charging stations
• Complementors for cars: paved roads and highways, auto financing
and insurance, repair shops, GPS services, used car markets,
guidebooks.
• Companies have to pay close attention to their complementors. If
there is a gap they need to fill it either themselves, other companies
or by lobbying the government (e.g. infrastructure)
Value net of education institute
Customers
Students, parents, government,
companies, donors

Competitors Complementors
Other institutes, online courses, Education Institute Schools, colleges, computers, Web
corporate training, professional services, employers, housing,
certificates restaurants, copy shops

Suppliers
Faculty, staff, publishers, online
services, maintenance services
Added value
• The difference between the value with the company and the value
without the company.
• A company has large added value when it creates a unique product
with loyal customers. Alternatively large economies of scale and high
efficiency can also provide strong added value.
• In addition to creating a thriving value net it is crucial for the company
to increase its added value because it will determine the share of the
profits that it obtains.
• It should also pay close attention to other stakeholders and make sure
none of them have too much added value.
Nintendo Entertainment System
• Videogame industry stared in the 1970s but experienced a major
crash in 1983 with a lack of quality control and an excess of badly
designed games.
• Nintendo launched the Famicom system in Japan in 1983 and
launched it in the US in 1985, called the NES.
• Nintendo kept costs low by using an inexpensive commodity chip and
sold the Famicom at $100.
• It also created high-quality games designed by their top designer
Shigeru Miyamoto including Donkey Kong, Super Mario Bros and
Legend of Zelda.
Virtuous circle
• Cheap hardware and Nintendo’s own high quality titles stimulated sales.
• Higher sale drove down manufacturing costs.
• They also attracted third party game developers who created games for the
NES.
• More games attracted more console sales which further drove down costs
and attracted more game developers and so on.
• This virtuous circle or network effect also acted as a barrier to entry since a
potential competitor would have the opposite problem of struggling to sell
consoles without games and struggling to attract developers without an
installed base.
Strict licensing controls
• Nintendo built a security chip into the hardware to ensure that only
Nintendo-approved games could run on the system.
• It also imposed restrictions on third-party developers like an annual
limit of five titles.
• Games were also subject to Nintendo approval.
• Licensees were also restricted from release the same title on another
video system for two years.
• These strict controls helped rebuild confidence in videogames after
the 1983 crash. Because of Nintendo’s dominance, game developers
had few options.
Shortages
• Nintendo kept tight control of the supply of games and sometimes
there was a shortage relative to demand, e.g. in 1988.
• However because Nintendo was so dominant, this did not hurt them
much and may have even produced benefits.
• The shortages made headlines and often desperate parents would
buy slower-selling Nintendo games and then also buy the popular
games later.
• The shortages also meant that retailers were desperate for Nintendo
games and had little bargaining power.
Success
• By the end of the 1980s Nintendo had achieved more than 90%
market share in the 8-bit video game market.
• One in three Japanese and US households had a Nintendo device.
• Nintendo products were 20% of the entire US toy industry.
• The Mario Bros games series had topped 40 million copies.
• Nintendo had achieved a high added value in a moderately sized
value net while the other players had little added value.
Nintendo Value net
Customers:
Toys R Us
Walmart (retailers)

Competitors: Complementors:
Atari,Commodore Nintendo
Electronic Arts, Acclaim
(hardware) (software)

Suppliers:
Ricoh, Sharp (chips) Disney,
Marvel (characters)
3DO
• Founded by Trip Hawkins, who also founded Electronic Arts.
• 3DO created the first 32-bit CD-rom based game system which was
launched in 1993.
• Business model was to make money with a $3 royalty much lower
than rival consoles. The company licensed the hardware technology
for free.
• IPO in May 1993 with the price rising form $15 to $48 by Oct.
• The first 3DO machine was sold in Oct 1993 for $700 by Matsushita.
• However games were limited and expensive at $75 and by Jan 1994
only 30,000 units were sold
New strategy
• The company realized that it needed to change strategy by 1994.
• It offered manufacturers incentives to lower the price of hardware to
$400.
• It created a “market development fund” by imposing an additional $3
surcharge of software developers
• However it was too late and by 1996 it faced competition from Sega
and Sony whose Playstation with 32-bit technology was launched at
$300 and became a big hit.
Key lessons
• There is strong complementarity between videogame hardware and
videogames and a new entrant needs to be strong in both like
Nintendo with the NES and its own successful games.
• 3DO was too late to launch its own titles and especially for a new 32-
bit CD-ROM technology where game development costs were high $2
million compared to $0.5 million for 16-bit cartridges.
• Because of the virtuous circle of hardware and software sales, a
console has to be priced aggressively at launch, for example the NES
was launched at $100 in 1986. This is often achieved by cross-
subsidies which are paid for by relatively high software licensing fees.
Conclusion
• Building a successful value net is a difficult balancing act because the
company’s relationship with the other players is simultaneously co-
operative and competitive.
• The company has to ensure the other players participate in the value
net without becoming too powerful.
• The company has to keep a close eye on key complementors and
make sure they are available at the right price and quality. Sometimes
like with Nintendo and videogames you have to make them yourself.
Core competence, Resource-
based view
Resource based view of the Firm
• What is the source of superior long-term corporate
performance?
• RBV says the tangible and intangible resources controlled
by a firm
• Tangible: Land, buildings, machinery equipment. Control
of raw material in particular can be valuable .e.g. Saudi
Armaco
• Intangible: Brands, Intellectual property, Trademarks.
These are more likely to provide differentiation and
lasting value
• To provide sustainable competitive advantage resources
need to be heterogenous and immobile.
VRIO
• To build sustainable competitive advantage the firm
needs to have resources which are:
• Valuable
• Rare
• Inimitable: Costly and difficult to imitate
• Organized: the firm must be organized to capture
the value from these resources.
Example
Google and data-based human capital management
• Valuable: this clearly creates value by making
employees more productive in an industry where
software talent is essential.
• Rare: Few companies use data and analytics in their HR
processes as systematically as Google.
• Costly to Imitate: Difficult to change long-standing HR
processes and norms.
And also the firm must be Organized to capture the value
from these resources: Google has the IT/analytics skills to
execute and the organizational culture to exploit
analytics.
Core competence
• Closely related to the resource based view is the
core competence approach by CK Prahalad and Gary
Hamel.
• A core competence is defined as a "harmonized
combination of multiple resources and skills that
distinguish a firm in the marketplace"

• Three characteristics of a core competence:

1. Difficult to imitate
2. Provides value to users
3. Can be applied in multiple industries
Examples
• Once a company develops a core competency it can
often redeploy it to other industries:
Company Core competence Initial industry Diversification
Casio Miniaturization, precision casing Watch Pocket TVs
Canon Optics, imaging Cameras Copiers, scanners
Honda Engines, powertrains Cars, motorcycles lawnmowers
Nokia and Samsung
• In 2010 both had similar strengths in terms of hardware capabilities;
Nokia was especially strong in phone cameras and Samsung in
displays.
• Both had strong global brands and distribution networks
• Both faced a similar external environment where software platforms
like Android and iOS were becoming increasingly dominant.
• Yet over the next few years, Samsung expanded its sales, revenues
and profits rapidly while Nokia fell behind and ultimately ceased
being an independent company.
• Why?
Strategy and core competence
• The answer lies in the different strategies of the two companies.
• Samsung was platform-agnostic and produced devices for multiple
platforms. Whichever platform succeeded Samsung was in a good
position to thrive based on its hardware and marketing competencies.
• Nokia tried to build its own software platform but did not have the
competency to build a modern smartphone OS and application
ecosystem with sufficient speed.
• Samsung’s strategy matched its core competences while Nokia’s
didn’t.
Mixed strategies
• Pure strategy: player picks one of their strategies with probability 1.
• Mixed strategy: player randomizes over their strategies.

Penalty kick game: a simplified version of penalty kicks.

Two players: striker and goalkeeper.
Striker has a choice between kicking left and right.
Goalkeeper has a choice between diving left and right (from the pov of the striker).
We assume that if the goalkeeper dives correctly the goal is stopped, otherwise a
goal is scored. E.g. if both go left, the goal is stopped.
Payoff: Striker gets 1 if goals is scored , otherwise 0.
Goalkeeper gets 1 is goal is stopped, otherwise 0.
 Penalty kick game
Goalkeeper

Dives left Dives right

Striker Kicks left 0,1 1,0
Kicks right 1,0 0,1

There is no Nash equilibrium in pure strategies. There is a Nash equilibrium in mixed

strategies where each player goes left or right with 0.5 probability.
Co-ordination game
• Two companies Boeing and Airbus have to decide on a choice of
communications technologies: Alpha and Beta.
• There are economies of scale so if both companies choose the same
technology it will lower costs.
• However both companies also prefer one of the technologies maybe
because of better compatibility with their existing technology.
Co-ordination game
Airbus

Alpha Beta
Boeing
Alpha 100,50 40,40
Beta 25,25 50,100

What are the Nash equilibria?

(Alpha, Alpha) and (Beta,Beta) are the Nash equilibria. Boeing prefers the first one and Airbus
the second one.
Sequential games
• Instead of moving simultaneously, the two players move in order or
sequentially.
• After the last move, both players receive a payoff depending on the
earlier moves of each player.
• Sequential games can be modelled using a game tree.
• Each player seeks to maximize their own payoff.
Sequential co-ordination game
100,50 These games are played
Alpha
forward but solved
backward through the
Airbus Beta principle of backward
Alpha 40,40
induction.
The outcome of this
Boeing Alpha 25,25
Beta game is that both Boeing
Airbus and Airbus play
Beta Alpha.(100,50).
50,100 This is an example of first-
mover advantage.
Entry game (small network)
High P
4,6 Newcom
enters and
Oldcom
Oldcom Low P
Enter -1,2 charges a
high price
Newcom High P 0,16 (4,6)
Stay out
Oldcom Low P
0,7
Entry game (large network)
High P 4,2 Oldcom
now has a
Oldcom Low P credible
Enter -1,4
threat of
charging a
Newcom High P 0,10 low price if
Stay out
Oldcom Newcom
Low P enters.
0,6 Newcom
stays out
and Oldcom
charges a
high price.
(0,10).
Entry game(full)
4,6 In this
High P
game,Oldcom
will build a
Oldcom Low P large network
Enter -1,2
which will deter
Newcom from
Small Newcom High P 0,16
Stay out entering and
network
Oldcom Oldcom will
Low P charge a high
0,7
price (0,10).
Oldcom High P 4,2
Large
network
Oldcom Low P
Enter -1,4

Newcom High P 0,10

Stay out
Oldcom
Low P
0,6
GAME THEORY AND STRATEGY
TOPICS
Introduction to game theory, price wars
Sequential games, entry deterrence
4 strategy models:
Porter Model: 5 competitive forces that shape the industry
Co-opetition model: how a company simultaneously co-operates and competes with
stakeholders
Core competence: the key strengths of a company that drive profitability
Blue Ocean Strategy: how a company can create a new product space largely free
from competition.
OLIGOPOLY
Market structures with a small number of sellers.
Many major industries are oligopolistic in nature: automobiles, telecom, airlines, soft
drinks etc.
Strategic interaction: each company’s decision will affect its competitors and vice
versa
Require new set of tools to analyze called game theory
GAME THEORY
Branch of applied mathematics which looks at strategic interaction between rational decision-
makers.
Wide range of applications: Oligopoly analysis, auctions, political strategy, international
relations, evolutionary biology, sports.
Basic elements of a game:
Players: entities which compete against each other and take decisions
Strategies: choices that the players have to make
Payoffs: a number that represents the outcome of the game and which depends on the
strategies chosen by each player.
In a game with two players with two strategies each there will be four pairs of payoffs. We
assume that each player will pick a strategy to maximize their own payoff.
DOMINANT STRATEGY
Player 2
Left Right
Player 1 Up 4,3 3,2
Down 2,4 1,1

A dominant strategy gives the player a higher payoff regardless of what the other player plays. If
each player has a dominant strategy, you get a dominant strategy equilibrium.

In this game the dominant strategy equilibrium is (Up,Left) giving a payoff of 4 to Player 1 and 3
to Player 2
 NASH EQUILIBRIUM
Player 2

Left Right
Player 1 Up 3,4 2,1
Down 1,2 4,3

Nash equilibrium: no player can gain by unilaterally changing their strategy. Assuming
other players continue with the same strategy, each player is better off also staying with
the same strategy.

In this game there are two Nash equilibria (Up,Left) and (Down,Right).
Every dominant strategy equilibrium is a Nash equilibrium but the reverse is not true.
PRISONER’S DILEMMA
Prisoner 2

Not Confess Confess

Prisoner 1 Not Confess -1,-1 -6,0
Confess 0,-6 -3,-3

For each player, confessing is a dominant strategy and therefore Confess,Confess is the dominant strategy
equilibrium and unique Nash equilibrium. However both players can be better off not confessing. However that is
not a Nash equilibrium and if you know the other player will not confess you are better off confessing.
 DUOPOLY
Indigo

High Price Low Price

High Price 300,300 100,400
Spice Jet
Low Price 400,100 200,200

The DSE and unique NE is Low Price,Low Price. However both players would be better off if they
could charge a high price. This is like a prisoner’s dilemma
DUOPOLY OF WATER SELLERS
Two water sellers. For convenience we assume zero cost. Each water seller decides how much water to
bring to thePrice
Quantity market?Total
They face (profits)
revenue a downward sloping demand curve.
(gallons) The sum of the amount by the two sellers
0 120 0 determines the price.
10 110 1100 Each seller’s profit is their amount
20 100 2000
multiplied by the price (because costs are
zero)
30 90 2700
E.g. if Seller 1 brings 10 and Seller 2
40 80 3200
brings 20, the total amount is 30 gallons
50 70 3500 and therefore the price is 90.
60 60 3600 Seller 1: profit of 900
70 50 3500 Seller 2: profit of 1800
80 40 3200
90 30 2700
100 20 2000
DUOPOLY
If both pick 30 gallons, the price is 60, what is the profit?
Ans: 1800
Assuming the other seller sells 30 gallons, can the first seller increase their profit?
Ans: Yes by selling 40 gallons and earning a profit of 2000
What happens if both sellers sell 40 gallons?
Ans: Price is 40 and both earn a profit of 1600.
GAME

Seller 2

30 gallons 40 gallons
Seller 1 30 gallons 1800,1800 1500,2000
40 gallons 2000,1500 1600,1600

For both sellers 40 gallons is a dominant strategy and 40,40 is a Nash equilibrium
leading to profits of 1600. Yet both would be better off if they could restrict
output to 30 gallons.
 GENERALIZED PRISONER’S DILEMMA
Duopolist 2

Co-operate Defect
Duopolist 1 Co-operate R,R N,T
Defect T,N P,P

Examples of co-operation would be charging a high price or selling a small amount. Defection would
be an aggressive strategy like lowering price or selling a larger amount.
The logic of the prisoner’s dilemma holds if T(temptation)>R(reward)>P(punishment)>N(naïve)

This framework could also be used to analyse strategic decisions like product-launches and
aggressive marketing.
In general it helps us understand industry rivalry. (Defect,Defect) is an outcome where the companies
are acting aggressively to grab market share from each other.
(Co-operate,co-operate) is a state of low rivalry where companies are not acting too aggressively.
REPEATED PRISONER’S DILEMMA
1 2 3 4 5 6 ….
SJ HP HP LP LP …
Indigo HP HP HP LP …
The repeated prisoner’s dilemma repeats the PD game multiple times. It is more realistic and leads to a
range of possible outcomes. For example if one company deviates by charging a low price it will
obtain a higher payoff for one period but will then suffer from retaliation in future periods.
The exact equilibrium will depend on specific factors like the payoffs and the discount rate of the
players.
FACTORS THAT INFLUENCE PROBABILITY OF A
PRICE WAR
Price-sensitive buyers: does lowering price increase sales sharply?
This makes price wars more likely.
Volatility of demand/technology: do industry conditions change rapidly?
This makes price wars more likely.
Concentration: Is the market share highly concentrated with a small number of companies?
This makes price wars less likely.
Symmetric or asymmetric firms: Are the firms similar or different in terms of technology, productivity etc.?
If similar this makes price-wars less likely, if dissimilar or asymmetric a price war is more likely.
Secret prices: are prices publicly revealed?
This makes price wars more likely.
Lumpiness of orders: does the typical buyer buy in bulk?
This makes price wars more likely.
PORTER MODEL
N Sawaikar
INTRODUCTION
 Porter model first detailed in Competitive
Strategy by Michael Porter in 1980
 To a large extent it applied basic economic
concepts like the structure-conduct-performance
paradigm to general business analysis
 The aim of the model is to analyse the basic
forces that affect industry profitability and
provide a guide to successful strategy
FIVE FORCE MODEL
PROFITABILITY OF SELECT INDUSTRIES
RIVALRY AMONG EXISTING FIRMS
 What is the nature of competition: price or non-price? Price
competition tends to erode profits. Non-price competition is often
consistent with sustained profitability.
 Excess capacity: pressure to raise sales, firms can easily steal
business from rivals
 Rivals have long-term goals beyond short-term profitability e.g.
state owned companies want to increase employment.
 Diversity of competitors may mean that firms are unable to
analyse other firms’ intentions and therefore make a price war
more likely
 High exit barriers like highly specialized assets and long-term
labour agreements will help prolong rivalry
 Price rivalry is greater if:
 Products are similar with little differentiation.
 High fixed costs, low marginal costs.
 Perishable product
THREATS TO ENTRY
Above-average returns will always attract potential entrants into
an industry. Defending high profitability means there have to be
barriers to entry.
Barriers to Entry:
 Supply-side economies of scale, high fixed costs which can be
spread across more units
 Demand-side benefits of scale: network effect the more users the
better the product
 Capital Requirements
 Product Differentiation, Strong Brands
 Distribution Channels
 Switching Costs
 Government policy: licensing rules, patent protection, import
restrictions.

 Barriers to entry will depend on the technological features of the

industry. However firms can raise barriers to entry through their
strategy by building brand loyalty and raising switching costs.
BARGAINING POWER OF BUYERS
 Bargaining power of buyers is high:
 If buyer purchases a large proportion of seller’s sales.
 Product is standardized and has few switching costs.
 Buyer is well-informed about demand, supplier costs etc.

 Backward integration can increase bargaining power of

buyer.
e.g. retail sector backward integrating into FMCG or
electronics
 Government is often an important buyer which can use
bargaining power to reduce prices. E.g. Pharmaceuticals
BARGAINING POWER OF SUPPLIERS
The following factors affect bargaining power of suppliers:
 If supplying industry is concentrated it will have more
power. E.g. aircraft manufacturing.
 Few substitutes for product that is being supplied
 If the industry isn’t important customer for supplier group
 Supplier group has a credible threat of forward integration

Labour must also be considered an important supplier.

Eg. Power of unions
THREATS OF SUBSTITUTES
 Competition comes not just from within the industry but
from products which perform the same function outside
the industry.
 Sometimes the substitute may be quite different from the
original industry. E.g. equity brokers face indirect
competition from real estate markets as an avenue for
investment
E.g. Video-conferencing may be a substitute for business
travel.
 Substitute products are especially important if:
a) They face favourable trends in terms of cost/performance
b) They are produced by an industry producing high profits
THREE STRATEGIES
 Porter identifies three strategies for coping with
the five forces:
 Cost Leadership
 Differentiation
 Focus

The first two are the most important and a

fundamental point of the Porter model is that
there is a trade-off between the two
COST LEADERSHIP
1. Economies of Scale
2. Cost minimization should be pursued systematically across different
divisions: R&D, sales, advertising etc
3. Intense supervision of labour
4. Ease of manufacture
5. Incentives based on quantitative targets

 Cost leadership provides protection from rivals because low-cost firm

will earn profits at lower prices giving it greater staying power in a
price war
 Factors that provide low-cost leadership typically result in high
barriers to entry because of scale advantages
 E.g. Walmart, McDonald’s

Risks from cost leadership strategy:

 Technological progress that nullifies learning
 Economic growth that creates demand for superior products
 Inability to adjust to innovation because of low R&D budgets
E.g. Ford and General Motor in 1920’s
DIFFERENTIATION
 Differentiation means creating a product or
service which is viewed industry-wide as being
unique
 Differentiation can come through brand-image,
technology, customer service etc.
 This strategy requires strong marketing skills,
R&D and engineering skills and a reputation for
quality
 E.g. Tesla, Apple,Nike

 Risks:

Price differentials become too large

Brand differentiation declines as industry matures
and buyers become more educated
POSSIBLE TO COMBINE THE TWO?
 A fundamental claim of the Porter model is that
it is not possible to combine cost leadership and
differentiation (a focus strategy is a possible
exception)
 He argues that firms that do this will fall
between two stools and lose both the high-volume
customers who want low prices and customers
who want high quality
 He also claims that firms that pursue both
strategies will suffer from conflicting and
confused corporate culture
 E.g. Kmart which lies between cost-leader
Walmart and differentiator Target.
CRITIQUE OF THE PORTER MODEL
 Is there really a trade-off between low-cost and quality. Why can’t a firm
provide both through hybrid strategies?
E.g. Blue Ocean strategy
 Porter model doesn’t have much to say about internal organization of the
firm as compared to the industry.
In contrast the core competence model looks at the unique capabilities of the
individual company.
 Porter model focuses on rivalries between firms, suppliers, buyers rather
than potential co-operation. In contrast, the co-opetition model looks at
both competition and co-operation.
 Porter model is industry-centric. How do you define an industry? In some
industries especially in the IT sector, competition comes from outside
industry lines.
 Finally from the point of view of public policy, the Porter model may
violate the principles of a competitive economy. A successful strategy may
involve pursuing high returns by reducing the amount of competition