Blue Ocean Strategy

What is the Blue Ocean Strategy?

Blue Ocean Strategy (German Blue-Ocean-Strategie, Strategie des blauen Ozeans) refers to an approach to corporate strategy under which a company opens up new demand in a market space that is not yet occupied. This means an area of demand that no provider has so far served in a targeted way. The counter-model is competition in an existing market, in which established providers compete for the same customers. The approach calls this market a red ocean, as an image of competition that drives down prices and margins; it calls the newly created market space a blue ocean. Its guiding idea is value innovation, that is, the simultaneous increase in customer value and reduction in costs.

The approach was developed by W. Chan Kim and Renée Mauborgne, professors at the INSEAD business school. It became well known in 2005 through their book of the same name, published in German as "Der Blaue Ozean als Strategie". In financing documents, it appears in the chapter on positioning and competition in the business plan and in the equity story, the account of why the company will grow. There it is often linked with the claim that the company is creating a new product category. Before they decide, investors check such claims in due diligence for supporting evidence, above all for the willingness to pay of the customers addressed.

Basic idea: value innovation and non-customers

The classic competitive strategy according to Michael Porter assumes that a company must choose between cost leadership and differentiation. It should therefore either be the cheapest provider or make a special offer for which customers pay more. The Blue Ocean Strategy questions this assumption. It recommends eliminating or reducing industry-standard features of low customer value and directing the resources freed up into new features. The aim is to create an offer that is more attractive to a new customer group and at the same time cheaper to produce.

The new demand is meant to come above all from non-customers. This means organisations that use the industry's offer only reluctantly, deliberately reject it or were never regarded as customers by the industry. For market size, it follows that this cannot be read off the industry's current revenue. The total addressable market (TAM) has to be determined here from the needs of these non-customers, not from an industry statistic.

Tools: strategy canvas and Four Actions Framework

The strategy canvas shows, for each competitive factor of an industry, such as price, functional scope or implementation effort, how strongly a provider addresses it. This gives its value curve. If the curves of most providers resemble one another, they are competing on the same factors; a blue ocean shows up in a clearly different curve.

The Four Actions Framework puts four questions to the industry factors:

• Eliminate: which factors that the industry takes for granted can be dropped entirely.
• Reduce: which can be lowered well below the industry standard.
• Raise: which should be lifted well above the industry standard.
• Create: which factors that the industry does not yet offer should be newly created.

If the fields "Eliminate" and "Reduce" remain empty, costs rise with every new feature. What usually emerges then is a more expensive variant of the existing offer, not a value innovation.

Informative value and limits from an investor's perspective

For investors, the Blue Ocean Strategy is a useful way of thinking, but not proof. The statement of operating in a market without competition allows two interpretations. Either the company has recognised a need that no one has served so far, or there is not enough demand for the offer. Which interpretation applies is decided not by the strategy but by data: paid orders, conversion rates from pilot projects (the share of pilot customers that sign a regular contract), contract renewals and prices actually achieved.

Investors view further points critically:

• Cost of building the market: A new market space first has to be explained; longer sales cycles and higher customer acquisition costs therefore belong in the financial model.
• Imitability: If the approach works, imitators appear. What matters is what the company builds up in the meantime in terms of customer relationships, data, switching costs (lock-in effect) and brand awareness.
• Selection in hindsight: The usual showcase cases are successes selected after the fact; whether a market space remains unoccupied can hardly be judged in advance.

Practical example: blue ocean strategy for inspection software in small businesses

A software company offers a solution for quality inspection in small manufacturing businesses. The established providers sell extensive systems with implementation projects lasting several months and licence prices aimed at large businesses; many small businesses therefore document their inspections on paper. The Four Actions Framework yields:

• Eliminate: on-site implementation projects and custom programming
• Reduce: functions for group reporting and multilingual support
• Raise: usability on mobile devices and setup in one day
• Create: automatically generated inspection records for customer audits and a price per inspection station instead of a licence for the whole business

The target group consists predominantly of non-customers, that is, businesses that have not so far bought software for this purpose. Investors therefore look less at competition than at demand. They ask about the share of businesses that pay after a trial phase, about churn after the first contract year and about customer acquisition costs. They expect the market size as a calculation based on the substitute, that is, on the effort of today's paper documentation. With freely chosen figures:

• Target group: 20,000 small businesses with inspections subject to documentation requirements
• Current effort per business: 4 hours per week × 46 working weeks × EUR 45 per hour = EUR 8,280 per year
• Price per business: 2 inspection stations × EUR 1,500 = EUR 3,000 per year, around 36% of today's effort
• Market size based on the substitute: 20,000 × EUR 3,000 = EUR 60 million per year

For the individual business, the offer pays off as soon as the software saves a little more than a third of the previous time spent. A possible saving is not yet a willingness to pay, however. The market size of EUR 60 million becomes viable only when pilot customers confirm the saving and pay after the trial phase. At the same time, investors examine how quickly established providers could offer a simplified version of their system.

Distinction: niche, disruptive innovation, product-market fit

• Niche: a small segment of an existing market with the same competitive factors. A blue ocean, by contrast, changes the factors themselves and addresses non-customers.
• Disruptive innovation: according to Clayton Christensen, an offer that begins at the low end of the market or with non-customers and gradually displaces established providers. A blue ocean does not presuppose displacement.
• Product-market fit: the proof that an offer convincingly serves a sufficiently large demand. Only with product-market fit does a blue ocean become a viable business.

Common mistakes

• Absence of competition as an argument. The statement that there is no competition is read as a lack of market knowledge. It is more convincing to name today's substitute.
• Only cutting. Anyone who merely leaves services out creates a cheaper offer in the same market, not a new market space. Without the fields "Raise" and "Create", the gain in value is missing.
• Demand asserted instead of proven. A new market space without paying customers is a hypothesis. Pilot contracts, conversion rates and prices actually achieved are the evidence investors expect.
• Durability assumed. A lead without lock-in effects, data or brand awareness ends as soon as established providers react.
• Market figure of the red ocean. Anyone who uses today's spending in the existing market as the market size is describing precisely the market the company wants to leave. For non-customers, the calculation based on the substitute fits.

Frequently asked questions

What examples of the Blue Ocean Strategy are there?

The best known come from the book itself. A circus dispensed with animal acts and stars and took on elements of the theatre. A wine producer offered a deliberately simple range for people who had rarely bought wine before. Both cut industry standards that their target group valued little, and thereby won non-customers. Because such cases are selected in hindsight, they show that the approach can succeed, not how often.

Can the approach also be applied in business with corporate customers?

Yes. It is precisely there that many industry standards rest on habit, such as long implementation projects, fixed minimum terms or pricing models that exclude small customers. Eliminating them can open up customer groups that have not bought so far.

Do investors value a company in a new market space more highly?

Not as a matter of course. What is decisive is demonstrable growth and good customer retention; without them, the risk that demand is smaller than assumed outweighs.

How long does a blue ocean remain unoccupied?

This cannot be said in general. A profitable market space attracts imitators; how quickly depends on how hard the offer is to copy and how strongly customers are already tied in.

How is the market size of a blue ocean determined?

From the bottom up, based on the substitute (bottom-up market sizing), because published market figures do not exist for a new market space. The organisations with the need are counted and valued at the effort of their current solution or at the willingness to pay that first contracts demonstrate. In the market analysis, today's substitute is then the focus of the competition section.

The Roemer Capital view

If a company describes its positioning as a new market space, we first check the demand evidence when preparing a funding round. This includes paying customers from groups that have not so far bought a comparable solution, and their retention after the first contract year. Only when this evidence is available does the picture of the blue ocean support the equity story.

If it is missing, we advise a sober presentation: the offer as a clearly different solution in an existing market, with a named substitute and named competitors. It is easier to substantiate in due diligence and leaves open whether a new market space emerges later.