Value innovation. How to create uncontested market space and make the competition irrelevant

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1 Value innovation. How to create uncontested market space and make the competition irrelevant 1. What can we learn from W. Chan Kim & Renée Mauborgne, Blue Ocean Strategy ( Boston, Mass.: Harvard Business School Press, 2005.) Jochen Röpke Bandung, August 31, 2005 Seminar & Panel Discussion Blue Ocean Strategy in Business & Research Fakultas Ekonomi, Program Pascasarjana, Universitas Padjadjaran I am looking at the book from K & M from two perspectives, a theoretical and a practical. Both are connected. A good theory is also of great practical value. As the philosopher Kant has said: The most practical thing is a good theory. The theoretical point of view I apply is innovation and entrepreneurship theory, especially the one coming from the Austrian economist Joseph Schumpeter. This is not arbitrary, since the authors s book is about innovation, they call it value innovation, and since they consider Schumpeter as a source for their own ideas, also as an author which they believe to have prevailed over. Where Schumpeter failed, they succeeded. To mention new growth theory (Paul Romer and others) as an approach to have overcome Schumpeterian innovation (p. 210) we consider as a theoretical faux pas. The practical point is directly connected with the how-question of K & M: how to create uncontested market space and how to make competition irrelevant. This is a bold how. How-question, compared to why-questions are important for practice, application, doing. The answer to an how-question really should say us how to proceed, how, by which steps and procedures we can proceed to create sales and profits (without worrying about competition). If somebody promises me: how to live forever, I really want to know, how I can do this, not only theoretically, but what I have to do, in practice, to live forever, and if I follow the rules, do indeed live forever (if the theory, on which the how is based, is really good in the sense of Kant). 2. What is new? Benchmarking Schumpeter In Capitalism, Socialism and Democracy, Schumpeter (1947, p. 132) writes: [T]he function of entrepreneurs is to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of material or a new outlet for products, by reorganizing an industry and so on. This [entrepreneurial] function does not essentially consist in either inventing anything or otherwise creating the condition which the enterprise exploits. It consists in getting things done. Do K & M move beyond this? Schumpeter explicitly mentions as one kind of innovation the creation of new markets (Schumpeter, 1911, p. 174). He thus is, similar to K & M, employing a blue ocean strategy. It is thus more than selling a given product or a qualitatively improved product at a lower price (due to technological progress and/or economies of scale). Schumpeter explicitly rejects red ocean strategies as part of what an innovator is (should be) doing. 1

2 Similarly to K & M, the focus of Schumpeter is on the creation of new values (Schumpeter calls it future values, Zukunftswerte, values, that are realized in the future by the innovating entrepreneur). He thinks, given the constraints under which existing firms operate (see our last point), that value creation, in most cases, but not exclusively, is done by new firms (start ups). The more radical the innovation, the more the implementation, the carrying out, has to be done by new firms. So far, indeed, each new basic innovation, including the ones mentioned by our authors, has been created by new firms. Established firms are masters in marginal, incremental, small innovation, within a given product cycle. If I am not mistaken, K & M lie their focus on established firms. This follows the tradition in management thinking. All the examples and case studies are taken from established firms who seem to have transformed themselves in order to create new value through innovation. But this has to be checked more carefully by examining the examples in the book. Are the American companies Net Jet and Southwest Air new firms as Ryan Air in Europe and the many low cost airlines in East Asia? In opposite to K & M, Schumpeter and other innovations theorists are sceptical concerning the advantages of analyzing ex ante the chances of innovation. They also doubt the role of profits as an objective of business, so much stressed by K & M (pp.135-7). Entrepreneurs follow their vision and intuition. If some one is analyzing every possibility, he never will act (1911, p. 177): paralyzing through analyzing. It is refreshing to read: Focus on the Big Picture, not the numbers. That of course is against what many management thinkers are advising us to do. But thinkers like Kenichi Ohmae (The mind of the Strategist), come to similar conclusions. To be fair, also our authors are having reserves concerning number crunching. But they give detailed information concerning the steps needed to create value innovation. This could indeed be a big step forward, if the how question can be answered. The blue ocean examples from history the authors provide are exactly those discussed at some length by innovation theory. Many industries as basic a automobiles, music recording, aviation, petrochemicals, health care (pp. 5-6). 3. Product cycle and blue ocean What is the difference between creating a new product life cycle and creating a value innovation (blue ocean innovation)? Are not the later phases in a product cycle similar or the same as red ocean products? The authors say (p. 17), that value innovation is more than innovation. That is only correct, if the authors imply (what they sometimes do), that innovation is identical with technological innovation. This of course is not the case. The first automobile was nothing more than a wagon, formerly drawn by horses, now powered by an engine. Product innovation often uses new technology, in most cases, new products and new technology (production functions) interact synergetically. In many examples of the authors, this also is the case (mobile telephoning, telecommunications, Japanese NTT). Indeed, they cannot be separated! They are two sides of the same coin. The authors (pp ) suggest a pioneer-migrator-settler map. What is the difference to the product cycle logic. What new insights are provided? 4. Creative destruction The authors seem to imply that no creative destruction takes place. (Destruction is red ocean). Creative destruction means that new products destroy old products as the computer did with the type writer. They maintain that through value innovation, no demand is taken away from old (red ocean) producers. Blue oceans... are defined by untapped market space, demand creation (p.4). People still need money to buy blue ocean products. Where does this money come from? They must either get a loan from a bank, dis-save, or take the money away from existing products.it is very probable also, that the demand for blue ocean products reduces the demand for established products in the sense that people have limited time, resources and 2

3 competencies to consume new products without discarding old ones. If you visit the new type of circus once a month, other things have to go away (television, football, writing your dissertation) because of a time constraints. This reduces the demand for other products. If the new products offer superior value to customers, a main thesis from the authors, this necessarily implies that consumers are less interested in buying conventional products. The example from the authors make believe us, that creative destruction does not happen anymore, since indeed new customers (demand) have been created out of nothing (examples wine; circus). But non-wine drinkers turning to wine must finance their purchases. How? Result: less demand for existing products, at least indirectly. In some of the examples, direct creative destruction happens. Airlines: Net Jets takes away business customers from conventional airlines; computers: Dell takes away customers from other suppliers, some even going bankrupt. CNN devastated the competitors (ABC, CBS, NBC, p. 97). So the empirical picture is really mixed. Blue and red oceans intermingle, the water between the two oceans is travelling from the one to the other. The authors have to accept what the economist Milton Friedman said long ago: There is no free lunch (in the economic world). Everything has to be paid for. In other words: value innovation has both an element of additional demand and an element of destructive demand. In the red ocean there is only marginal innovation; when A increases sales, B loses sales, no creative destruction is involved, only destruction, displacement, as when Chinese t-shirts destroy European clothing producers. In the blue ocean, competition proceeds through innovation in products (often inseparable connected with technological innovation). Creative destruction is directly or indirectly (redirecting purchasing power from old to new products) involved. This means: also in the blue ocean, sharks are looking for prey. 5. Where does demand come from? Demand in a developing economy (= blue ocean?) is created, according to Schumpeter, by the entrepreneur. He does not adapt to given needs, but forces his innovation, more or less, on his customers (1911, pp.133-4). It is the quality of the innovation, that opens up a new market, hitherto not satisfied by existing products. It is not primarily a matter of price and costs. Therefore he moves beyond existing demand (p. 4), a characteristic of red ocean competition. Is extra demand really out there, largely untapped (K & M, p. 211)? Is not the re-constructing of existing buyer value elements more or less the same as the recombination of resources leading to a new product? What happened when the railway substituted the stagecoach, and the motorcar competed with railways? When reading what they write about innovation theory (pp ), I think the authors either misunderstood the prevailing approaches or constructed differences in order to differentiate their thinking from Schumpeter and others. You cannot reduce Schumpeter et al. to technical possibilities versus new market space. 6. Has competition become irrelevant? In blue oceans, competition is irrelevant (p. 5). Difficult to understand. So long as resources are scarce, competing for them is always necessary in market capitalism. 7. Implementation: how to do it? The do question is the action-question. How those who like to apply what they studied in the book can apply it? The authors try to answer this question in the last part of their book: Overcome key organizational hurdles (chapter 7). To do it, they use a case study: the New York City Police Department. That is, a case very different from this presented in the book to illuminate their theory. We can learn to run a business better from studying a police department in New York. But we would learn more, if the implementation problems would have been illustrated with the examples from blue ocean competition. Police men have no competitors. There is no red ocean. There is no creative destruction. 3

4 What we learn how to conquer the blue ocean falls short, in my opinion, of what we need to learn to implement the strategy offered in the book. One illustration: how to get the resources for value innovation? The authors argue similarly to Schumpeter (1911). Instead of focusing on getting more resources, tipping point leaders concentrate on multiplying the value of the resources they have (p. 156). Leaders need to free up resources... (p. 158). This is similar to the mechanism of development stressed by Schumpeter: recombining given resources in a new way. Established Firms are fortunate in that they own already resources for recombination, for initiating a blue ocean value innovation. Most firms fail in this. And the book, for me, does not illustrate, how to prevent this failure. The example of the police department the authors use is problematic. Established firms must take away resources from departments and products that contribute to cash flow and that are owned by managers fighting any recombination. The police chief can act as a dictator, the CEO cannot, not to mention blue ocean product champions. Christensen has demonstrated how difficult it is to overcome these problems (The authors mention the book of Christensen: The innovator s dilemma, but do not mention Christensen s argument in their writing). One difficulty: all things start small, also value innovation. The impact on sales and profits at the beginning is marginal. Established firms are thus not interested in these things, since the contribution of innovation (which may fail) to profits remains so low. They prefer to buy into expanding markets via acquisition and merger. Resistance to change in established organizations is a big problem. K& M have useful and helpful things to say about this (pp ). It reminds me on the innovation promoter model (power promoter, knowledge promoter etc.) we find in the literature on innovation management. The way out of these problems, for Schumpeter and Christensen alike: start a new firm. You become your own boss. You can do what you like. If you are good, you get the financial capital for carrying out value innovation from business angels and venture capitalists (not from banks). If this fails, use your own money through 4F (founder, family, friends, fools). K & M tell us, that established firms can manage a blue ocean strategy. Several times they say, new firms are not necessary for value innovation. May be they are right. But how to do it, I would like to learn from them, having an interest to value innovate on my own. 8. New firms As someone also engaged in helping people to set up their own firms, the book may help them better to achieve this goal. It provides insights and search routines for how to enter the world of the Blue Ocean. Whether they will meet in this world competitors or not (as the authors claim) is not the important thing. Far more important is to take root in the market, to establish products which can be sold profitably and the most valuable: provide new firms with advantages, gained through the rigorous thinking and creative strategies required to come up with value innovation. This can provide them with competitive advantages not available through conventional red ocean thinking and doing, still largely taught in management schools. New firms, not yet chained to the path dependencies of established products and technologies and the organizational fiefdoms based on them, can thus gain, despite meager resources and lack of experience, competitive advantages over incumbent players. In this sense, I believe Schumpeterian innovation combined with blue ocean thinking and doing can indeed provide new firms with crucial advantages, more difficult to b be realized by established enterprises. This argument can easily be extended to emerging economies. Since latecomers are able to master new knowledge as effective as mature economies, they can employ Schumpeterian Blue Ocean Management to gain footholds in the global economy without the cost reduction strategies and the implied human costs of conventional macro- and micromanagement. This does not rule out of course, to employ an portfolio approach in learning to swim in the oceans of the world economy: combining (for some sectors and products) red ocean doing, for others blue ocean innovation. 4

5 Summary The book makes interesting reading. It may have practical application going beyond conventional innovation management. From a theoretical point of view, the argument is at times inconsistent. The basics of the theory do not go beyond Schumpeter et al. The main thesis uncontested market space, that means no competition must be rejected. We have not yet achieved the state of nirwana. The how-question remains to be answered. Nevertheless, we can learn much from this kind of thinking, which is easily combined with innovation entrepreneuring and management in the sense of Schumpeter and Christensen. I would advise especially new firms to study carefully, how they can implement what the authors have to say about value innovation. Literature Christensen, Clayton M. (1997): The innovator s dilemma. Boston: Harvard Business School. Ohmae, Kenichi (1982): The mind of the strategist: The art of Japanese business. New York: McGraw-Hill. Schumpeter, Joseph A. (1911): Theorie der wirtschaftlichen Entwicklung (Theory of economic development), first edition, Leipzig, republished Berlin, Duncker & Humblot in