: Chapter #6

Blue Ocean – Ch. 6: Get the Strategic Sequence Right Now we need to build a robust business model to ensure a healthy profit You need to ensure the commercial viability of your business, and do it in this order Buyer utility – is there exceptional buyer utility in your business idea Price – is your price accessible to the mass of target buyers Cost – can you achieve cost target to profit at your price Adoption – what are the hurdles facing you If you can answer all of these questions, you have a commercially viable product

No-rethink Yes

Blue Ocean – Ch. 6: Get the Strategic Sequence Right Buyer Utility Does your offering unlock exceptional utility? What is/are those exceptional utility(ies)? Is there a compelling reason for people to buy your product? What are those reasons, and are they valid? If the answer is NO then there are no Blue Oceans here, either stop or re-think the idea Setting the Right Price You cannot rely solely on price to create demand How will you test the right price? Will you create focus groups and test strategic pricing strategies? But Price is a critical component of customer attraction If it is you will create exceptional ‘Buzz’ These first 2 steps address the Revenue side of the business model

Get the Strategic Sequence Right Now lets look at the Cost and Profit side of the equation Can you produce the offering at the target cost and still make a profit? Do you control the manufacturing costs, or are you buying from third part vendors? What is the relationship between raw materials and labor in the cost mix If costs are the only driver of Price you might be in trouble Price must also be a function of buyer utility, or else it is ‘false pricing’ The cost side of the company’s business model is a ‘partner’ in the creation of profit (Price minus cost) Value innovation is a combination of exceptional utility, strategic pricing and target costing This combination allows for the creation of Blue Oceans

Get the Strategic Sequence Right Now let’s address “adoption hurdles” These will include potential resistance to the idea by retailers or partners The key is to address these hurdles is to do it ‘UP FRONT’ In order to complete this task we now need to look at the FOUR important questions in more detail Testing for Exceptional Utility Sometimes we become so engrossed with the idea or the novelty of our offering we fail to assess real buyer utility Can anyone remember the Philips CD-I from the early 90’s? It cost Philips millions of dollars and it failed miserably It was a video machine, music system, game player and teaching tool that totally CONFUSED CONSUMERS Worst of all it had not software titles to drive demand Consumers lacked a compelling reason to buy it Unless the offering makes my life better, simpler, less risky, more convenient or more fun I do not want it

The Philips CD-i It wasn’t until October of 1991 that the thing finally hit the store shelves. By then it was too late The buzz, what little there was left, had evaporated The devices were large and clunky and carried by outlets such as Sears and Radio Shack The public was confused by the software since it looked like a CD- ROM (which was now entrenched) but wasn’t a CD-ROM It virtually died right on the spot, and the $800 price point didn’t help! Also the picture was muddy and the responsiveness was mediocre.

Get the Strategic Sequence Right The Buyer Utility Map This will help us look at the issue of being trapped into making the product technically great versus functional to its customers Cust. Productivity Simplicity Convenience Risk Fun & Image Environmental friendliness Purchase Delivery Use Supplements Maintenance Disposal

Get the Strategic Sequence Right The 6 Stages can be broken down into a cycle running from purchase to disposal Cutting across the stages of the buyer experience are called utility levers These are ways that the company can unlock exceptional utility from buyers Most of these levers are self explanatory Simplicity, fun & image and environmental friendliness need clarification Customer productivity makes the life of a customer better or making it faster Look at the model T Ford for example Before the Model T the only care were for the wealthy, it was luxury and style that mattered, but the roads were awful Thus the use of cars was limited and inconvenient Thus the use of cars was limited and inconvenient The cars also required a great deal of maintenance and were fickle technically

Get the Strategic Sequence Right The Model T Ford The Model T was called the car for the great multitude It came in only one color – Black with scant options Ford thereby eliminated the huge investment in image Instead of making a luxury car for the weekend rich person, Ford created a car for everyday use It was reliable, it was easy to maintain and it traveled easily over dirt roads and in the rain It was easy to fix and easy to drive – you could learn to drive in 1 day You have to check if your offering passes the exceptional utility test like the Model T Then find out how our idea can be refined to become more functional You must ascertain where the greatest blocks to utility across the buyer experience cycle are Then figure out of your offering eliminates these blocks

History of Model T ford’s

From Exceptional Utility to Strategic Pricing To secure a strong revenue stream for your offering, you must set the right strategic prices This ensures that buyers will (i) want to buy it and (ii) be able to afford it Look at the example of Flat Screen TV’s and the pricing strategy they MISUSED (early adopters) It is critical to know from the start what price will capture the mass of target buyers The two reasons for this are (i) higher volumes generate higher returns that they used to (Microsoft XP cost over $1 b to create, but once more CD cost $0.22) and (ii) the value of a product may be closely tied to the total number of people using it. For example look a eBay Buyers will not buy unless they see others bidding Look at the phenomenon of QVC, either they sell thousands of the item or none at all The strategic price must not only attract buyers, it must help retain them as well Since Brand Building begins on day one, your reputation be earned quickly to use word-of-mouth (powerful – Nordstrom’s) If you do not accomplish this you will invite “free riding”

Price Corridor of the Masses When setting a price, companies look first at products/services that most closely resemble their idea in terms of form They look at products/services in their industries The challenge then is to understand the price sensitivities of the buyers who will be comparing the new offering with all other similar offerings Products will almost always fall into 2 categories 1: Those that take different form but perform the same function Look at the Model T Ford, which looked at horse-drawn carriages Look at the Model T Ford, which looked at horse-drawn carriages Both had the same core utility – transportation for families Both had the same core utility – transportation for families Ford converted non-customers into customers by pricing the Model-T against the Horse drawn carriage Ford converted non-customers into customers by pricing the Model-T against the Horse drawn carriage 2: Those that take different forms and functions but share the same over -arching objective Some companies lure away customers from even further away Some companies lure away customers from even further away Cirque du Soleil diverted customers from a wide variety of evening activities Cirque du Soleil diverted customers from a wide variety of evening activities Bars, night clubs, restaurants all have the same objective as Cirque, namely “to enjoy a night out” Bars, night clubs, restaurants all have the same objective as Cirque, namely “to enjoy a night out” Listing groups of alternative products allows managers to see the full range of buyers they can poach from other industries Listing groups of alternative products allows managers to see the full range of buyers they can poach from other industries Once you have done this you must then plot the price……………..

Price Corridor of the Masses Step 1: Identify the price corridor of the mass Three alternative product/service types: Step 2: Specify a price level Within the price corridor Different form Same Different form and function Form same function same objective Different form Same Different form and function Form same function same objective Price corridor of the Mass Size of the circle is proportional to number of buyers that product/service attracts High degree of legal and Resource protection Difficult to imitate Some degree of legal and Resource protection Low degree of legal and Resource protection Easy to Imitate U.L.P. M.L.P. L.L.P. ULP - Upper level pricing MLP - Middle level pricing LLP - Lower level pricing

Specify a level within the Price Corridor Now we need to determine how high we can price the product before inviting competition from imitators This depends on two factors (i) the degree to which the product/service is legally protected (copyright-patent) (ii) if the company owns an expensive plant which might block imitation Dyson, the British vacuum cleaner company can charge high prices for its products, thanks to strong patent and a hard-to- imitate product If you do not have a strong set of protection in these factors, you should consider pricing somewhere in the middle of the corridor If you have no protection you must price in a relatively low manner, such as Southwest airlines (competes with cars) You should consider mid to lower boundary pricing if; (i) Your blue ocean offering has high fixed costs and small variable costs (ii) The attractiveness of the product/service depends heavily on network externalities (rely on many buyers/users) (iii) Cost structure can benefit from economies of scale, and volume brings significant cost advantages

From Strategic Pricing to Target Costing Target costing addresses the profit side of the business To maximize profit a company should start with the ‘strategic price’ and deduct the desired profit margin to arrive at cost This is what we call price-minus costing and not cost-plus pricing This will allow you to reach a cost structure that is both profitable and hard for followers to match By introducing a production line, Ford was able to replace skilled workers with unskilled workers, and reduced the time to make a car from 21 days to FOUR HOURS – cutting labor by 60% To hit your cost target there are THREE principal levers; First you have to streamline operations and find new cost innovations from manufacturing to distribution Can high-cost and low-value activities be eliminated, reduced to outsourced? Can the location of your distribution facility be located in low rent areas (Wal-Mart, Home Depot, Curves, IKEA)? Can you minimize the number of parts in your product (Swatch and Model-T Ford)?

From Strategic Pricing to Target Costing Take a look at how Swatch revolutionized the watch business Swatch lowered the cost structure of a watch by 30% Nicolas Hayek set up a team to determine the strategic price for a watch At the time cheap Japanese and Hong Kong watches were selling for $75 and capturing the mass of customers Swatch set the price at $40 – a price that allowed customers to buy more than one Fashion Statement watch The lower price left NO margin for Japanese and Hong Kong watches at all Swatch accomplished the strategic price by radically changing the product and the manufacturing process Swatch engineers reduced the watch from 150 to just 51 parts thereby reducing costs by 30% The price was hard to beat for the competitors, and the Fashion component was brilliant marketing, and lured in non- customers as well

From Strategic Pricing to Target Costing A Second Lever is created by streamlining operations and introducing cost innovation Partnering is another way that a company to secure needed lower cost capabilities It allows the company to leverage other companies’ expertise and economies of scale (customer service call centers) At IKEA a large part of ability to meet target prices comes from partnering with some 1500 manufacturers in 50 countries SAP the world’s largest business application software maker, saved hundreds of millions of dollars in development costs by purchasing a world class database from Oracle SAP instead of hiring a large sales force, used Capgemini and Accenture (consulting firms) to sell the product to their own customers

From Strategic Pricing to Target Costing A THIRD lever is accomplished by changing the pricing model of the industry, and not the level of strategic price When videotape movies came out they were priced around $80 each Few people were willing or able to pay that large a price (going to the movie was about $6) The answer came in the form of a total B.O.S. called Blockbuster who overcame the $80 issue by simply renting the movie and making back enormous returns on the $80 IBM accomplished the same results by “leasing” computer instead of trying to sell mainframes in the $500,000 range NetJets simply leases you a SHARE of the jet for a fraction of what it would cost you to own and operate a Jet aircraft Hewlett-Packard invested tens of millions of dollars into Silicon Valley start-up’s for a share of their revenue and technology developed This is what we call pricing innovation

The Profit Model of B.O.S. The Strategic Price The Target Profit Goal The Target Cost Goal Streamlining and Cost innovations Partnering Pricing Innovation

From Utility, Price and Cost to Adoption Even a great B.O.S. threatens the ‘status quo’ For that reason it may threaten the three main stakeholders; Its employees Its Business Partners The General Public Therefore before moving ahead on the new idea, the company MUST first overcome fears by educating the fearful Merrill Lynch failed to announce plans for their online brokerage business, and their stock fell by 14% as reports came out about in-fighting at the company Before coming out with you nee idea you must make a huge effort to communicate to employee and get their buy-in Even more damaging than employee disaffection is resistance from your business partners Lastly you must communicate your new idea to the general public carefully (Monsanto makes generically engineered foods, and were attacked by European green consumers for “dangerous products”)