CHAPTER 2 The Fundamentals of Market-Creating Strategy

BEFORE SHOWING YOU HOW to make a blue ocean shift—how to move your organization from market competing to market creating—we first need to clarify what market-creating strategy really is and how it works.

We’ve seen a lot of confusion on this through the years, as some people have difficulty understanding how various perspectives on market creation fit together. Some equate market creation with creative destruction or disruption. They think you need to destroy or disrupt an existing market in order to create a new one. Others regard market creation as a matter of innovation, and often see technology as the key to unlocking new markets. Still others view market creation as synonymous with entrepreneurship and believe it to be the domain of entrepreneurs.

All these views are partly right. But they are also partly wrong, because each offers an incomplete picture of how markets are created. Without having a complete picture, efforts to make a blue ocean shift will miss many opportunities and may even be misdirected. So here we build a holistic model of market-creating strategy that shows not only the available strategic options and how they produce blue ocean shifts, but also their corresponding growth consequences. Using this model, we can understand how these existing partial views fit together in the big picture.

Creative Destruction and Disruptive Innovation Are Only Part of the Picture

In speaking with executives, entrepreneurs, and government leaders, one consistent pattern we’ve observed is how often they associate market creation with the concepts of creative destruction or disruption. Creative destruction is the iconic term coined by the Austrian economist Joseph Schumpeter, who observed that although competition in existing markets is good, diminishing returns eventually set in as buyers’ needs are satisfied and profits are competed away.1 The real engine of economic growth, he argued, is therefore the creation of new markets. But, in his view, this creation is dependent on destruction.²

Destruction occurs when an innovation displaces an earlier technology or an existing product or service. The word displacement is important here because without displacement, creative destruction does not occur. For example, the innovation of digital photography creatively destroyed the photographic film industry by effectively displacing it. So today digital photography is the norm, and photographic film is seldom used.

The concept of disruption echoes Schumpeter’s insight.³ The most well-known study on disruption directly relevant to market creation is the influential idea of disruptive innovation.⁴ Whereas creative destruction occurs when a superior technology, product, or service comes along and destroys the old with the new, disruptive innovation begins with the arrival of an inferior technology, which then crosses the line from inferior to superior and, in doing so, displaces market leaders. The classic example here is the disruption and eventual displacement of leading disk drive players, which were caught off guard by bottom-up disruptors that initially entered the scene with simpler technology and inferior performance.5

The distinguishing insight here is that the technology waltzing into an industry need not be superior, as Schumpeter suggests, but instead can come in as a Trojan horse whose initial inferiority does not appear to threaten the mainstream market. As a result, established players ignore the newcomer until it’s too late. What these ideas have in common, however, is their shared focus on the displacement of existing players and markets.

As business history shows that there are ample cases of both forms of displacement, focusing singly on either creative destruction or disruptive innovation in discussions of market creation would be partial and misleading. Hence, to describe the act of market creation that embraces both forms of displacement, we coined the term disruptive creation.⁶ This broader term captures the full, not partial, opportunity space of market creation driven by displacement.

Important as disruptive creation driven by either creative destruction or disruptive innovation is, however, it still misses another universe of market-creating opportunities. As our research shows, many new markets have also been created without disrupting existing ones.⁷

Nondisruptive Creation Also Generates New Markets and Growth

If you have children and live in any one of 147 countries around the world, from the United States, to Afghanistan, to Germany, Japan, or Yemen, you have heard of Sesame Street. Big Bird, Elmo, Ernie, and Bert are just a few of the lovable Muppets that teach preschool children how to count, name their colors and shapes, and recognize the letters of the alphabet. And the best part is that children have so much fun watching the program they don’t even realize how much they’re learning. But parents do, which is why they love it too. It’s the antithesis of what many people associate with education. It seduces and amuses as it educates the very young.

Sesame Street didn’t disrupt any prior market for early childhood education. It didn’t destroy and replace preschools, or libraries, or parents reading bedtime stories to their children. Rather, Sesame Street opened up a new value-cost frontier that unlocked the new market of preschool edutainment that, for the most part, had never existed before. In contrast to “disruptive creation,” Sesame Street is the result of what we call “nondisruptive creation,” as it created new market space without disrupting an existing market.

Now put children aside and turn to men. Many men’s lives were revolutionized through Pfizer’s market-creating move of Viagra. But did Viagra disrupt another market? Again, the answer is no. It was nondisruptive creation. By alleviating erectile dysfunction, Viagra solved a prevalent and previously unaddressed problem and took the world by storm. Demand for it rapidly grew into a multibillion-dollar business, creating a new market space of lifestyle drugs.

Now think of the more than 3 billion people who live on only a few dollars a day. Here, too, nondisruptive creation stepped in to solve an unaddressed problem: the lack of access to capital that was driving the poverty cycle. In 1983, Grameen Bank began offering microloans without requiring collateral, enabling people to start businesses or engage in agriculture and climb up the income ladder while paying off a small debt. This strategic move created the new market of microfinance without replacing any other market. Until then, conventional banks had simply ignored the poor, whom they deemed unsuitable as borrowers. Microfinance has since ballooned into a multibillion-dollar industry with plenty of room for future growth. While climbing, it still reaches less than 20 percent of the potential new market, which today is served by both nonprofit and for-profit organizations around the world.

Online dating, health clubs, crowdfunding, ringtones, and routers, switches, and network devices are just some of the myriad multibillion-dollar industries that have been created in the last few decades through nondisruptive creation. Today, in fact, the fastest-growing profession in the United States, second only to information technology, is based on nondisruptive creation. It’s life coaching. Just 25 years ago, the industry did not exist. Now it boasts annual revenues north of US$2 billion. The advent and growth of the life-coaching industry have not come at the expense of any existing industry. Tens of thousands of new coaching jobs have been created without destroying any other jobs. Rather, the industry has created new demand, as people flock to life coaches to become more effective in both their personal and professional lives.

As these examples illustrate, our research indeed demonstrates that growth has always been generated by market-creating moves based on both disruptive and nondisruptive creations.8 To illustrate, consider the evolution of industrial classification standards in the United States. In 1997, the North American Industry Classification Standard (NAICS) replaced the more than half-century-old Standard Industrial Classification (SIC) system published by the US Census. In the new system, industries were not only merged or replaced but also created, with the number of sectors doubling from 10 to 20. The services sector under the old system, for example, was expanded into 7 industry sectors, ranging from information to health care and social assistance.

Since 1997, the NAICS system has been revised several times to keep up with the pace of industry creation, re-creation, and growth. For example, while the information sector was expanded significantly in the 2002 version, the 2017 version included changes to 6 out of the 20 NAICS sectors to reflect new market creation. In both these new versions, some existing industry classifications were replaced, while entirely new categories were also created to recognize the emergence of brand-new industries. Given that these systems are designed for standardization and continuity, such changes underscore the impact that both disruptive and nondisruptive creations have in shaping existing industry boundaries and creating new ones.

Getting the Full Picture

Try this short exercise. Ask a group of people to look around a room for 30 seconds and make a mental note of every red item they see. As soon as the time is up, ask them to close their eyes and recall every blue item they saw. That’s right blue. People will have trouble recalling many items at all. What we look for determines what we see. When we assume that the only way we can create a new market is by disrupting an old one, opportunities for nondisruptive creation can be easily missed. People tend to focus their attention on the core of existing markets and what it would take to disrupt the existing order. This narrows their vision and blinds them to the wealth of nondisruptive market-creating moves they could make.

Consider the potential advantages of expressly including nondisruptive creation in your strategic thinking. First, take start-ups. When entrepreneurs set out to disrupt an existing market, they often face established players with many, many times the financial and marketing resources the start-ups have. While it’s true that David sometimes beats Goliath, and the emotional pull of the story looms large, more often than not it’s the other way around. As a new start-up, do you really want to be up against well-entrenched leaders? Maybe. And that’s certainly one way to go. But you don’t have to—that’s the important point. The opportunities for nondisruptive creation loom just as large, and entrepreneurs would be unwise not to take them into account as well.

Second, consider established players. In established organizations, fear of losing one’s job or current status through creative destruction or disruptive innovation can prompt managers to undermine their organization’s market-creating efforts. They may starve such projects of resources. Or allocate undue overhead costs to them. Or relegate the employees working on them to corporate Siberia, which inevitably makes them want out. Microsoft and many other established organizations struggle with issues like these. Growth through nondisruptive creation is less threatening, because it doesn’t directly challenge the existing order and the people who make their livelihoods through it. So, by framing their market-creating strategy in a broader context that embraces both disruptive and nondisruptive creations—as blue ocean shift does—established organizations can better manage their organizational politics and the anxieties of their key people.

Finally, consider new jobs. When disruptive creation occurs, new jobs are created. Often, a lot of jobs. But old jobs are lost. So, when the cassette tape replaced the 8-track, which was replaced by the CD, which was later challenged by the MP3 player, each successive new market created new growth and employment. But they came, in part, at the expense of jobs from, and sometimes the very existence of, the preceding businesses. By contrast, nondisruptive creation produces both growth and employment without necessarily displacing existing businesses or industries.

We do not raise these points to stress the advantages of nondisruptive over disruptive creation. Rather, we wish to show you why nondisruptive creation should also be incorporated into your strategic thinking. We need a holistic model of market-creating strategy that embraces both disruptive and nondisruptive creations, since they are complementary.9 They separately and together open up new value-cost frontiers that are key to growth. Focusing on only one will lead to an incomplete and biased assessment of potential market-creating opportunities and limit your efforts to make a blue ocean shift.

A Holistic Model of Market-Creating Strategy

By now you may be asking yourself, “Which market-creating strategies result in disruptive creation and which result in nondisruptive creation?” In our research over the last 10 years, we found that the answer to this question comes down to the type of issue an organization sets out to address in making a market-creating strategic move.

Our research revealed three basic ways in which market-creating strategies—and hence blue ocean shifts—are made. You can:

• Offer a breakthrough solution for an industry’s existing problem.

• Redefine an industry’s existing problem and solve it.

• Identify and solve a brand-new problem or seize a brand-new opportunity.

Each of these approaches involves a different balance between disruptive and nondisruptive creation. The most effective way to show these relationships is through a graphic. Accordingly, figure 2-1 presents a holistic model of market-creating strategy. We call this graphic a “growth model of market-creating strategy” because it shows which strategic approach produces which kind of growth.

Let’s run through each of these in turn.

Figure 2-1

A Growth Model of Market-Creating Strategy

Offer a Breakthrough Solution for an Existing Industry Problem

When an organization creates a breakthrough solution for an existing industry problem, it strikes at the core of existing firms and markets, whether at the outset or over time. Let’s go back to our music example. CDs were a breakthrough solution to the problem of how best to store and replay sound recordings, which is a central challenge for people trying to enjoy music. In contrast to its predecessor, the CD offered “perfect sound forever,” skipping effortlessly from one song to another with none of the crackling and gumming up of twisted cassette tapes. Not surprisingly, in a short time, the CD replaced the cassette as the standard music medium. For years, people were thrilled with CDs—until, that is, Apple’s MP3 player, the iPod, came around and offered yet another breakthrough solution to the problem of storing and playing music. Again, people rushed in droves to replace their old, now passé and unwanted, CDs with Apple’s iPod and other MP3 players, which gave them easy access to their entire music library. In each case, the existing product was essentially replaced through disruptive creation.

In the same way, the internal combustion engine replaced the steam-powered engine by offering a breakthrough solution to power generation for motorized transport. Ditto for digital photography, which effectively replaced film photography with a far better way to take, develop, share, and store photos.

The main effect, therefore of developing a breakthrough solution to an existing industry problem is the displacement of existing offerings and jobs, as the old is disrupted by the new. Existing markets are re-created from their core and expanded beyond their previous boundaries, turning red oceans into blue. Growth occurs with this market re-creation and boundary expansion as the breakthrough solution pulls in new demand, converting once noncustomers into customers. Just think, for example, of how many more people today take photos with digital photography than took pictures with film in the past.

Identify and Solve a Brand-New Problem or Seize a Brand-New Opportunity

On the other end of the spectrum, organizations that identify and solve brand-new problems or create and seize brand-new opportunities unlock new markets beyond existing industry boundaries. Here disruptive creation is hardly at play. Think back to Viagra and Grameen Bank, which identified and solved problems that had not previously been addressed. Or think of Sesame Street and life coaching, which identified and created brand-new opportunities. All these moves established new markets beyond the bounds of any existing industry.

As our growth model indicates, solving a brand-new problem or capturing a brand-new opportunity results in nondisruptive creation because the new market hardly eats at the core, or even the margins, of existing industries. This type of growth is nondisruptive to society as well, because it grows profits, revenues, and jobs—not to mention society’s imagination—without destroying any others. Areas like cybersecurity, obesity, life-long learning, virtual reality, the environment, and health services provide ample new opportunities for nondisruptive creation. So does the bottom of the pyramid—that is, opportunities to be found and new problems to be solved among the billions of poor people at the base of the financial pyramid.10

Redefine and Solve an Existing Industry Problem

In between solving an existing problem and identifying and solving a brand-new problem or creating a brand-new opportunity are market-creating strategies that redefine and solve the problem an industry focuses on. Problem redefinition allows an organization to replace assumptions and reconstruct industry boundaries in new and creative ways. Here both disruptive and nondisruptive creations are in full play. Take the well-known example of Cirque du Soleil. It made a leap in the kind and degree of value the industry offered by redefining the problem it focused on, from how to maximize the fun and thrill of the circus, to how to combine the best of it—clowns, tents, and amazing acrobats—with the best of theater and ballet—their artistry, music, dance, and story lines. It created a new market space between these industries, drawing a slice of demand from each. At the same time, it enlarged the overall pie by pulling new people into this blue ocean of newly created market space. Adults without children and corporate clients, who never dreamed of going to a circus before, became customers of Cirque du Soleil.

André Rieu and the Johann Strauss Orchestra also created a new market by redefining the problem the classical music industry focused on, unlocking both disruptive and nondisruptive creation. Dubbed the “maestro for the masses,” Rieu has consistently appeared on the top-ranking lists of touring concerts worldwide for the past 20 years, along with Coldplay, Beyoncé, and the Rolling Stones. Unlike traditional classical music orchestras, Rieu’s orchestra combines easy listening classical and waltz music—think the “Blue Danube,” “Barcarolle,” and “O Mio Babbino Caro”—with contemporary music like Michael Jackson’s “Ben” or Celine Dion’s hit, “My Heart Will Go On” that many people find more accessible. Rieu also moved away from pretentious theaters, choosing instead to hold his concerts in large stadiums with spectacular light and sound effects and a fun, interactive atmosphere. While major concert halls can seat, on average, a maximum of 2,000 people, Rieu’s stadiums can easily sell out at 10,000-plus people. While Rieu wins a slice of customers from classical music concerts, he also creates huge new demand by drawing a mass of new customers, including people who were previously put off by the formality and pretension of classical music. That’s because André Rieu’s orchestra, like Cirque du Soleil, strikes at the margins of these other industries, not at their core, by solving a redefined problem that doesn’t go head-to-head with the problem anyone else is solving.

Groupe SEB’s blue ocean shift, which we talked about in chapter 1, also belongs here. Groupe SEB redefined the problem its industry focused on from how to make the best electric French fry maker to how to make mouthwatering fresh, healthy fries with no frying. While ActiFry has won a slice of demand from the traditional electrical fryer market, the leap in the kind and degree of value the ActiFry delivers inspired people who had never bought a fryer to become customers, growing overall industry demand by nearly 40 percent in value. Likewise, by redefining conventional boundaries, the National Youth Orchestra of Iraq opened up a new value-cost frontier and brought in new customers. But, it did not replace other kinds of youth orchestras, although it drew some of the same audience.

Simply put, offering a breakthrough solution for an existing industry problem generally results in disruptive creation. Identifying and solving a brand-new problem or seizing a brand-new opportunity most often gives rise to nondisruptive creation. And redefining and solving an existing problem draws on elements of both disruptive and nondisruptive creations.

Focus on Value Innovation, Not Technology Innovation

When we speak to audiences around the world about market-creating strategy, we often begin by asking them to consider Google Glass, Motorola’s Iridium satellite phone, and Apple’s Newton personal digital assistant. “Were these market-creating moves innovation?” And “Were they commercial successes or failures?” Audiences usually answer “yes” to the first question and “failures” to the second.

Then we ask another set of questions: “Who invented the personal computer?” And “Who invented the home VCR?” When it comes to PCs, people most often reply Apple or IBM. As for VCRs, people come up with all sorts of consumer electronics companies, the most common being Sony or JVC. The right answers, we then tell them, are actually MITS and Ampex, respectively. Most people are not only surprised when they find that out, but also appear to be unfamiliar with either company.

Putting these conversations together reveals an important point about market creation. While technology innovators may lay extraordinary eggs, they are seldom the ones who ultimately hatch them. The focus of a successful market-creating strategy should be not on how to lay a technology egg per se, but rather on how to hatch the egg for its commercial success. Thus although MITS invented the first personal computer, it was Apple and IBM, among others, that dominated the new mass market for PCs by adapting the technology to produce a leap in buyer value. Likewise, although Ampex invented video recording technology in the 1950s, companies like Sony and JVC dominated the long-profitable home VCR industry by adopting the technology and making video recorders easy enough to use and affordable for the mass of buyers; in essence, converting a technology innovation into what we called value innovation.11

There’s no inherent reason that an organization can’t capitalize on its own inventions, and certainly some companies have succeeded in doing both. But history shows that egg laying and egg hatching are often performed by different players.¹² This, we suggest, may be one reason so many people don’t even recognize the names of technology innovators now gone from their markets and instead mistakenly believe the value innovators—the ones that hatch new markets—are the technology pioneers as well.

It’s a win for everyone if a market player lays the technology egg, hatches it, and opens up a profitable and growing new market space that others may eventually enter. But the key lesson to remember here is that to succeed in creating a new market, your focus must be on offering a quantum leap in value for buyers, not on technology innovation per se.¹³ Google Glass, Motorola’s Iridium, and Apple’s Newton all suffered by getting this wrong. Google Glass was considered unattractive, nerdish, expensive, and raised hugely uncomfortable privacy issues. The Iridium satellite phone was a technological feat that worked in the Gobi desert but not in buildings or cars, where people needed it most. As for Apple’s Newton PDA, well, it just didn’t do what it said it would, so it’s not surprising that buyers didn’t see value in it.

The fact is, successful market-creating strategies often don’t rely on technology innovation at all. Think of Grameen Bank’s microfinancing, Starbucks, or the National Youth Orchestra of Iraq—all created new markets with little or no bleeding-edge technologies. Even where technology is heavily involved, as with Salesforce.com or Groupe SEB’s ActiFry, the reason buyers love these offerings isn’t because of the technology. Buyers adore them because they are so simple, easy to use, fun, and effective. That is, they love them because the technology is fundamentally linked to a leap in buyer value.

Economics has long taught us that R&D and technology innovation, as measured by R&D spending and numbers of patents, are the central drivers of innovation and growth. This may be true at the macro level of the economy, which could be one reason people tend to think of technology innovation first when they think about creating new markets. But such reasoning does not necessarily hold true when we apply it to the micro level of the individual organization. To take one example, Apple’s R&D spending-to-sales ratio has been among the lowest of its IT peers over the last decade. Microsoft, on the other hand, has one of the highest rates of R&D expenditures and impressive research centers the world over. But while Apple has been one of the most—if not the most—innovative companies in the commercial world, it’s hard to think of a single market Microsoft created in the last 10 years.

As a prescient article in Time magazine on Dean Kamen, the inventor of the Segway Personal Transporter, noted at the time of the Segway’s launch: “One of the hardest truths for any technologist to hear is that success or failure in business is rarely determined by the quality of the technology.”14 The Segway was an engineering marvel, one of the most talked-about technology innovations of its day when it was launched in 2001. But that did not convince enough people to pay US$4,000–$5,000 for a product that left them in a quandary over where to park it, how to take it in a car, whether it could be brought on a bus or a train, and where it could be used—on sidewalks or roads? While the Segway was expected to reach breakeven six months after its launch, the company continued to lose money until it was sold in 2009.

When companies mistakenly assume new market creation hinges on breakthrough technologies, their organizations tend to push for products or services that are either too “out there”—ahead of their time, too esoteric, too complicated—or, like the Segway, lack the complementary ecosystem needed to open up a new market. In fact, many technology innovations fail to create and capture new markets even as they win accolades for their organizations. Think of TiVo, whose original DVR garnered a lot of fanfare and is in the US Patent and Trademark Office National Inventors Hall of Fame, but which left most people wondering what it did and why they would want it.

Blue ocean shift is built on this insight. Just as value innovation is a cornerstone of market-creating strategy, a successful blue ocean shift occurs only when unprecedented buyer value is created by opening up a value-cost frontier that didn’t exist before. Value innovation anchors innovation to the value it gives buyers, not to the cleverness of the technology. It can be achieved with or without new technology. This holds true whether your blue ocean market-creating efforts set out to provide a breakthrough solution to an existing industry problem, to redefine the problem your industry focuses on, or to identify and solve a brand-new problem or create a brand-new opportunity.

You Don’t Need to Be an Entrepreneur to Create a New Market

Are you true blue or bloody red? That’s the name of a simple but telling quiz we put together a decade ago. We give it to executives when we meet to get a sense of the situation they’re up against. It asks questions about, among other things, the ferocity of their competition, the pressure on their margins, and the intensity of the commoditization they face. People’s overriding response: They’re operating in red oceans and need to get out.15

Yet when we dig deep, we find that even when companies deliberately set out to create new markets, those efforts are usually geared less toward getting out of red oceans and more toward making further investments in existing, overcrowded markets. There is a mismatch between what organizations aspire and need to do and what they’re actually doing. Why? Apart from the familiarity of current markets and the everyday pressure competition poses, the answer, we believe, comes down to the way people think about and manage market creation.

Ever since Schumpeter, entrepreneurs have been seen as the chief drivers of innovation and therefore of market creation. Entrepreneurs take risks and learn through trial and error as they attempt to seize opportunities by applying their intuition and ingenuity. But for market creation to be an integral part of an ongoing organization’s strategy, it cannot be a random, high-risk endeavor, conducted through trial and error. It needs to be a reliable process that can be reproduced. Without that, as much as organizations may need to make market-creating moves, they will continue to shy away from investing accordingly.

Some progress has been made in this regard over the years.¹⁶ But we still need a market-creation process built on concrete market-creating tools that systematically link innovation to buyer value and provide guidance on how to apply them. More than that, the process must recognize and address people’s fear of trying new ideas and encourage them to push boundaries and overcome the forces and habits that keep them where they are. In short, it must be grounded in humanness to inspire people’s confidence.

As you will see, a humanistic, teachable, and systematic process makes market creation accessible to everyone, not just highly creative people or natural-born entrepreneurs. It allows ordinary people like us to create markets and do extraordinary things. With it, Paul MacAlindin, a classically trained conductor, was able to create a new type of orchestra that could inspire peace and hold up to the world a vision of the beauty of a united Iraq. With it, government leaders and ordinary civil servants in Malaysia collectively conceived a new way to deal with petty criminals, which dramatically cuts recidivism and gives these inmates the gift of a second chance while lowering the government’s costs.

It doesn’t matter what industry you’re in, or whether you consider yourself to be an entrepreneur. The process we will describe unlocks the potential all of us possess to see beyond what is to what could be. The success of such efforts is ultimately a probability game, of course, as all strategic initiatives are, be they red or blue ocean ones. Still, the whole point of strategy is to raise the probabilities of success, and that’s precisely what the blue ocean shift process does.

With that understanding, we are now ready to dive into the mindset of a blue ocean strategist. Adopting this mindset is essential to setting the right direction for your blue ocean shift. In the next chapter, we outline its defining features and explain why those features matter, so you can grasp the mental framing you will need as you embark on your own blue ocean shift journey.