Yesterday my MBA students and I discussed “Blue Ocean Strategy”, a popular book on strategic management by Kim and Mauborgne. A good thing about the book is that it encourages managers to be innovative and to pursue new markets rather than competing in highly competitive existing arenas, i.e., playing in “blue oceans” instead of “red oceans”. According to the authors, this way of thinking has served well for companies like Cirque du Soleil, Nintendo and Casella, an Australian firm that has succeeded in selling easy-to-drink wine in the US. Managers are encouraged to use the Strategy Canvas as an organizing framework (see here for an example). This encourages managers to ask themselves whether their products and services are really distinct after all, and along what dimensions they actually differ from the competition.

So far so good. But the problem is that in their enthusiasm, Kim and Mauborgne go on to make a tantalizing claim that the blue ocean approach allows you to break the tradeoff between pursuing differentiation and low costs. This puts them at odds with many leading strategy textbooks, which argue that it is often difficult for firms to increase consumer “willingness to pay” (WTP) while simultaneously reducing cost, all else being equal. You usually have to spend money on R&D, marketing and better execution in order to increase WTP. The “blue ocean” claim leads to all sorts of confusion among MBA students.

Does the blue ocean approach actually offer a silver bullet? Unfortunately not. The truth lies in the details. For a blue ocean strategy to work, you aren’t just supposed to add new activities that increase willingness to pay. You are also supposed to look for opportunities to eliminate or reduce others in order to cut costs. This is presented as the “ERRC” framework (pg 35 of the book) which asks managers to raise and create new dimensions for their product/service, while eliminating or reducing others. For example, Cirque du Soleil increased willingness to pay by introducing broadway-style themes, artistic music and dance, and better stage lighting to their productions. Meanwhile they reduced costs by eliminating animal shows and star performers, both of which are expensive cost components for a circus.

From the above it should be apparent that you still face a tradeoff between costs and willingness to pay. But you are just avoiding it by removing some of the costly activities. In other words, it isn’t the case that all else is equal. If Cirque du Soleil were able to offer all the new features in addition to having animals and circus stars (but at no marginal cost), then it would be legitimate to make a claim that the cost-WTP tradeoff had been broken. But fundamentally this tradeoff remains, and while the exciting new features enabled Cirque du Soleil to differentiate themselves from ordinary circuses and to increase ticket prices, the removal of animal shows and star performers inevitably meant that some customers who valued those things were now less willing to pay for a show.

Overall, the strategy map and blue ocean approach are useful because they encourage managers to think outside the box when looking for new competitive opportunities. But personally I find the distinction between blue and red oceans somewhat forced, especially when you realize that a firm produces multiple products, and these are likely to fall along a spectrum ranging from red to blue and beyond. So while the Nintendo Wii was blue ocean in approach, other Nintendo products at that time such as the DS were clearly not. In a fundamental sense, increasing WTP and reducing costs are complementary (Athey & Schmutzler, 1995). Hence, finding new and innovative opportunities to increase WTP and reduce costs should be something a manager ought to do anyways, regardless of whether their ocean is blue, red, purple or some other colour.