creating new - · pdf filecreating new market space pursue value innovation by looking across...

A systematicapproach to value

innovation can helpcompanies hreak

free from thecompetitive pack.

CREATINGNEWMARKETSPACE

by W Cliaii Kim aiid Rexiee Mauljorgiie

("COMPETING HEAD-TO-HEAD CAN BEcutthroat, especially when markets

^ are fiat or growing slowly. Managerscaught in this kind of competition almostuniversally say they dislike it and wishthey could find a hetter alternative. Theyoften know instinctively that innovationis the only way they can hreak free fromthe pack. But they simply don't knowwhere to hegin. Admonitions to developmore creative strategies or to think out-side the box are rarely accompanied hypractical advice.

For almost a decade, we have researchedcompanies that have created such funda-mentally new and superior value. Wehave looked for patterns in the way com-panies create new markets and re-createexisting ones, and we have found six ha-sic approaches. All come from lookingat familiar data from a new perspective;none requires any special vision or fore-sight ahout the future.

Most companies focus on matching andheating their rivals, and as a result their

W. ebon Kim is the Boston Consulting Group Bruce D. Henderson Chair Professor of Interna-tional Management at INSEAD in Fontainebleau, France. Renee Mauborgne is the INSEADDistinguished Fellow and Affiliate Professor of Strategy and Management, and presidentof ITM Research in Fontainehleau. They are the authors of "Value Innovation: The StrategicLogic of High Growth" (HBR fanuary-February 1997).

Strategies tend to converge along thesame hasic dimensions of competition.Such companies share an implicit set ofheliefs ahout "how we compete in our in-dustry or in our strategic group." Theyshare a conventional wisdom ahout whotheir customers are and what they value,and ahout the scope of products and ser-vices their industry should he offering.The more that companies share this con-ventional wisdom ahout how they com-pete, the greater the competitive conver-gence. As rivals try to outdo one another,they end up competing solely on the hasisof incremental improvements in cost orquality or both.

Creating new market space requires adifferent pattern of strategic thinking. In-stead of looking within the acceptedboundaries that define how we compete,managers can look systematically acrossthem. By doin<^ so, they can find unoccu-pied territory that represents a real break-through in value. This article will de-scrihe how companies can systematically

HARVARD BUSINESS REVIEW January-February 1999 S3

CREATING NEW MARKET SPACE

pursue value innovation by lookingacross the conventionally definedboundaries of competition - acrosssubstitute industries, across strategicgroups, across buyer groups, acrosscomplementary product and serviceofferings, across the functional-emo-tional orientation of an industry, andeven across time.

Looking AcrossSubstitute Industrieshi the broadest sense, a company com-petes not only witb the companies inits own industry but also with compa-nies in those other industries that pro-duce substitute products or services.In making every purchase decision,buyers implicitly weigh substitutes,often unconsciously. Coing into townfor dinner and a show? At some level,you've probably decided whether todrive, take the train, or call a taxi. Thethought process is intuitive for indi-vidual consumers and industrial buy-ers alike.

For some reason, however, we oftenabandon tbis intuitive thinking whenwe become sellers. Rarely do sellersthink consciously about how theircustomers make trade-offs across sub-stitute industries. A shift in price, achange in model, even a new ad cam-paign can elicit a tremendous re-sponse from rivals within an industry,but the same actions in a substituteindustry usually go unnoticed. Tradejournals, trade shows, and consumerrating reports reinforce the verticalwalls that stand between one industryand another. Often, however, the space betweensubstitute industries provides opportunities forvalue innovation.

Consider Home Depot, the company that hasrevolutionized the do-it-yourself market in NorthAmerica. In 20 years. Home Depot has become a$24 billion business, creating over 130,000 newjobs in more tban 660 stores. By the end of the year2000, tbe company expects to have over 1,100stores in the Americas. Home Depot did notachieve that level of growth simply by taking mar-ket share away from other hardware stores; rather,it has created a new market of do-it-yourselfers outof ordinary home owners.

Creating a New Value Curve

The value curve-a graphic depiction of the way a company or anindustry configures its offering to customers-is a powerful tool forcreating new market space. It is drawn by plotting the performanceof the offering relative to other alternatives along the key successfactors that define competition in the industry or category.

To identify those alternatives, Intuit, for example, looked within itsown industry - software to manage personal finances - and it alsolooked across substitute products to understand why customerschose one over the other. The dominant substitute for software wasthe lowly pencil.The value curves for these two alternatives mapout the existing competitive space.

The Value Curves in Personal Finance Before Quicken

high

low

personal financialsoftware

the pencil

pnce ease of use optionalfeatures

speed accuracy

Key elements of product, service, and delivery

The software offered relatively high levels of speed and accuracy.But customers often chose the pencil because of its advantages inprice and ease of use, and most customers never used the soft-ware's optional features, which added cost and complexity to theproduct.

There are many explanations for Home Depot'ssuccess: its warehouse format, its relatively low-cost store locations, its knowledgeable service, itscombination of large stores and low prices generat-ing high volumes and economies of scale. But suchexplanations miss the more fundamental question:Where did Home Depot get its original insight intohow to revolutionize and expand its market?

Home Depot looked at the existing industriesserving home improvement needs. It saw that peo-ple had two choices: they could hire contractors, orthey could buy tools and materials from a hardwarestore and do the work themselves. The key toHome Depot's original insight was understanding

84 HARVARD BUSINESS REVIEW January-February 1999


The key to discovering a new value curvelies in asking four basic questions:

Reduce

What factors should be reduced well below the industry standard?

Eliminate

What factors should beeliminated that the industryhas taken for granted?

Create

What factors should becreated that the industryhas never offered?

What factors should be raised well beyond the industry standard?

Raise

Quicken's Value Curve

Answering the four questionsled Intuit to create a newvalue curve, which combinesthe low price and ease of useof the pencil with the speedand accuracy of traditionalpersonal-financial software.

high

lowprice

Quicken

other personalfinancialsoftware

the pencil

ea5e of use optional speedfeatures

Key elements of product, service, and delivery

accuracy

why buyers would choose one substitute over an-other. (It is essential here to keep tbe analysis at tbeindustry, and not tbe company, level.)

Why do people hire a contractor? Surety not be-cause tbey value having a stranger in tbeir bousewbo will cbaige them top dollar. Surely not becausetbey enjoy taking time off from work to wait for thecontractor to show up. In fact, professional contrac-tors bave only one decisive advantage: tbey have spe-cialized know-how that the home owner lacks.

So executives at Home Depot bave made it tbeirmission to bolster the competence and confidenceof customers whose expertise in bome repair is lim-ited. They recruit sales assistants with significant

HARVARD BUSINESS REVIEW fanuary-Febmary 1999

trade experience, often former carpenters orpainters. These assistants are trained to walk cus-tomers tbrough any project-installing kitchen cab-inets, for example, or building a deck. In addition,Home Depot sponsors in-store clinics that teachcustomers sucb skills as electrical wiring, carpen-try, and plumbing.

To understand tbe rest of tbe Home Depot formu-la, now consider tbe flip side: Wby do people cboosebardware stores over professional contractors? Tbemost common answer would be to save money.Most people can do without tbe features tbat addcost to tbe typical bardware store. They don't needthe city locations, tbe neigbborly service, or tbe

85


nice display shelves. So Home Depot has eliminatedthose costly features, employing a self-servicewarehouse format that lowers overhead and main-tenance costs, generates economies of scale in pur-chasing, and minimizes stock-outs.

Essentially, Home Depot offers the expertise ofprofessional home contractors at markedly lowerprices than hardware stores. By delivering the deci-sive advantages of both suhstitute industries-andeliminating or reducing everything else-HomeDepot has transformed enormous latent demandfor home improvement into real demand.

Intuit, the company that changed the way indi-viduals and small husinesses manage their fi-nances, also got its insight into value innovation bythinking ahout how customers make trade-offsacross substitutes. Its Quicken software allows in-dividuals to organize, understand, and manage theirpersonal finances. Every household goes throughthe monthly drudgery of paying bills. Hence, inprinciple, personal financial software should be abig and broad market. Yet before Quicken, few peo-ple used software to automate this tedious andrepetitive task. At the time of Quicken's release in1984, the 42 existing software packages for personalfinance had yet to crack the market.

Why? As Intuit founder Scott Cook recalls, "Thegreatest competitor we saw was not in the industry.It was the pencil. The pencil is a really tough andresilient substitute. Yet the entire industry hadoverlooked it."

Asking why buyers trade across substitutes ledIntuit to an important insight: the pencil had twodecisive advantages over computerized solutions-amazingly low cost and extreme simplicity of use.At prices of around $300, existing software packageswere too expensive. They were also hard to use, pre-senting intimidating interfaces full of accountingterminology.

Intuit focused on bringing out both the decisiveadvantages that the computer has over the pencil-speed and accuracy-and the decisive advantagesthat the pencil has over computers-simplicity ofuse and low price-and eliminated or reducedeverything else. With its user-friendly interfacethat resembles the familiar checkbook. Quicken isfar faster and more accurate than the pencil, yet al-most as simple to use. Intuit eliminated the ac-counting jargon and all the sophisticated featuresthat were part of the industry's conventional wis-dom about "how we compete." It offered insteadonly the few basic functions that most customersuse. Simplifying the software cut costs. Quicken re-tailed at about $90, a 70% price drop. Neither thepencil nor other software packages could compete

with Quicken's divergent value curve. Quicken cre-ated breakthrough value and re-created the indus-try, and has expanded the market some 100-fold.(See the exhibit "Creating a New Value Curve.")

There is a further lesson to be drawn from theway Intuit thought ahout and looked across substi-tutes. In looking for other products or services thatcould perform the same function as its own. Intuitcould have focused on private accounting firmsthat handle finances for individuals. But when thereis more than one substitute, it is smart to explorethe ones with the greatest volumes in usage as wellas in dollar value. Framed that way, more Ameri-cans use pencils than accountants to manage theirpersonal finances.

Many of the well-known success stories of thepast decade have followed this path of lookingacross substitutes to create new markets. ConsiderFederal Express and United Parcel Service, whichdeliver mail at close to the speed of the telephone,and Southwest Airlines, which combines the speedof fiying with the convenience of frequent depar-tures and the low cost of driving. Note that South-west Airlines concentrated on driving as the rele-vant substitute, not other surface transportationsuch as buses, because only a minority of Americanstravels long distances by bus.

Looking Across Strategic GroupsWithin IndustriesJust as new market space often can be found bylooking across substitute industries, so can it befound by looking across strategic groups. The termrefers to a group of companies within an industrythat pursue a similar strategy. In most industries,all the fundamental strategic differences amongindustry players are captured hy a small number ofstrategic groups.

Strategic groups can generally be ranked in arough hierarchical order built on two dimensions,price and performance. Each jump in price tends tobring a corresponding jump in some dimension ofperformance. Most companies focus on improvingtheir competitive position within a strategic group.The key to creating new market space across exist-ing strategic groups is to understand what factorsdetermine huyers' decisions to trade up or downfrom one group to another.

Consider Polo Ralph Lauren, which created anentirely new and paradoxical market in clothing:high fashion with no fashion. With worldwideretail sales exceeding $5 billion, Ralph Lauren isthe first American design house to successfullytake its brand worldwide.

86 HARVARD BUSINESS REVIEW Tanuary-Febniary 1999


At Polo Ralph Lauren's inception more than 30years ago, fashion industry experts of almost everystripe criticized the company. Where, they asked,was the fashion? Lacking creativity in design, howcould Ralph Lauren charge such high prices? Yet thesame people who criticized the company hought itsclothes, as did affluent people everywhere. Lauren'slack of fashion was its greatest strength. Ralph Lau-ren built on the decisive advantages of the two stra-tegic groups that dominated the high-end clothingmarket - designer haute couture and the higher-vol-ume, but lower-priced, classical lines of Burberry's,Hrooks Brothers, Aquascutum, and the like.

What makes people trade either up or downbetween haute couture and the classic lines? Mostcustomers don't trade up to haute couture to getfrivolous fashions that are rapidly outdated. Nordo they enjoy paying ridiculous prices that canreach $500 for a T-shirt. They buy haute couturefor the emotional value of wearing an exclusivedesigner's name, a name that says, "I am different;I appreciate tbe finer things in life." They also valuethe wonderfully luxurious feel of the materials andthe fine craftsmanship of the garments.

The trendy designs the fashion houses work sohard to create are, ironically, the major drawback ofhaute couture for most high-end customers, fewof whom have the sophistication or the bodies towear such original clothing. Conversely, customerswho trade down for classic lines over haute couturewant to buy garments of lasting quality that justi-fies high prices.

Ralph Lauren has built its brand in the space be-tween these two strategic groups, but it didn't doso by taking the average of the groups' differences.Instead, Lauren captured the advantages of tradingboth up and down. Its designer name, the eleganceof its stores, and the luxury of its materials capturewhat most customers value in hante couture; itsupdated classical look and price capture the best ofthe classical lines. By combining the most attrac-tive factors of both groups, and eliminating or re-ducing everything else. Polo Ralph Lauren not onlycaptured share from both segments but also drewmany new customers into the market.

Many companies have found new market spaceby looking across strategic groups. In the luxury carmarket, Toyota's Lexus carved out a new spaceby offering the quality of the high-end Mercedes,BMW, and Jaguar at a price closer to the lower-endCadillac and Lincoln. And think of the Sony Walk-man. By combining the acoustics and the "cool"image of boom boxes with the low price and theconvenient size and weight of transistor radios,Sony created the personal portable-stereo market in

HARVARD BUSINESS REVIEW January-February 1999

the late 1970s. The Walkman took share from thesetwo strategic groups. In addition, its quantum leapin value drew into the market new customers likejoggers and commuters.

Michigan-based Champion Enterprises found asimilar opportunity by looking across two strategicgroups in the housing industry: makers of prefabri-cated housing and on-site developers. Prefabricatedhouses are cheap and quick to build, but they arealso dismally standardized and project an image oflow quality. Houses built by developers on-site offervariety and an image of high quality but are dramat-ically more expensive and take longer to build.

Champion created new market space by offeringthe decisive advantages of both strategic groups. Itsprefabricated houses are quick to build and benefitfrom tremendous economies of scale and lowercosts, but Champion also allows buyers to choosesuch high-end options as fireplaces, skylights, andeven vaulted ceilings. In essence. Champion haschanged the definition of prefabricated housing. Asa result, far more lower-to-middle-income con-sumers have become interested in purchasingprefabricated housing ratber than renting or buyingan apartment, and even some affluent people arebeing drawn into the market.

Looking Across the Chain of BuyersIn most industries, eompetitors converge around acommon definition of who the target customer iswhen in reality there is a chain of "customers" whoare directly or indirectly involved in the buyingdecision. The purchasers who pay for the product orservice may differ from the actual users, and in somecases there are important infiuencers. as well. Whilethese three groups may overlap, they often differ.

When they do, they frequently hold differentdefinitions of value. A corporate purchasing agent,for example, may be more concerned with coststhan the corporate user, who is likely to be far moreconcerned with ease of use. Likewise, a retailer mayvalue a manufacturer's just-in-time stock-replen-ishment and innovative financing. But consumerpurchasers, although strongly influenced by thechannel, do not value these things.

Individual companies in an industry often targetdifferent customer segments-large versus smallcustomers, for example. But an industry typicallyconverges on a single buyer group. The pharmaceu-tical industry, for example, focuses overridinglyon infiuencers - the doctors. The office equipmentindustry focuses heavily on purchasers-corporatepurchasing departments. And the clothing industrysells predominantly to users. Sometimes there is a


Strong economic rationale for tbis focus. But oftenit is tbe result of industry practices tbat bave neverbeen questioned.

Cballenging an industry's conventional wisdomabout wbicb buyer group to target can lead to thediscovery of new market space. By looking acrossbuyer groups, companies can gain new insights intohow to redesign tbeir value curves to focus on apreviously overlooked set of customers.

Consider Bloomberg. In little over a decade,Bloomberg bas become one of tbe largest and mostprofitable business-information providers in theworld. Until Bloomberg's debut in tbe early 1980s,Reuters and Telerate dominated the on-line finan-cial-information industry, providing news andprices in real time to tbe brokerage and investmentcommunity. The industry focused on purcbasers-tbe IT managers-wbo valued standardized sys-tems, which made tbeir lives easier.

Tbis made no sense to Bloomberg. Traders andanalysts, not IT managers, make or lose millions ofdollars for tbeir employers eacb day. Profit opportu-nities come from disparities in information. Wbenmarkets are active, traders and analysts must makerapid decisions. Every second counts.

So Bloomberg designed a system specifically tooffer traders better value, one with easy-to-use ter-minals and keyboards labeled witb familiar financialterms. Tbe systems also have two flat-panel monitors,so traders can see all the information they need atonce without having toopen and close numerouswindow s. Since traders baveto analyze information be-fore they act, Bloombergadded a built-in analyticcapability tbat works witbthe press of a button. Be-fore, traders and analystsbad to download data anduse a pencil and calculatorto perform important finan-cial calculations. Nowusers can quickly run"wbat if" scenarios to com-pute returns on alternativeinvestments, and they canperform longitudinal analy-ses of historical data.

By focusing on users,Bloomberg was also able tosee the paradox of traders'and analysts' personal lives.Tbey have tremendous in-com,e but work sucb long

hours that they have little time to spend it. Realiz-ing tbat markets bave slow times during tbe daywhen little trading takes place, Bloomberg decidedto add information and purchasing services aimedat enhancing traders' personal lives. Traders canbuy items like fiowers, clotbing, and jewelry; maketravel arrangements; get information about wines; orsearcb through real estate hstings.

By shifting its focus upstream from purchasersto users, Bloomberg created a value curve that wasradically different from anything tbe industry hadever seen. Tbe traders and analysts wielded theirpower within their firms to force IT managers topurchase Bloomberg terminals. Bloomberg did notsimply win customers away from competitors - itgrew tbe market. "We are in a husiness tbat need notbe eitber-or," explains founder Mike Bloomberg."Our customers can afford to bave two products.Many of them take other financial news servicesand us because we offer uncommon value." (Seethegraph "Bloomberg's Value Curve at Its Debut.")

Pbilips Lighting Company, the North Americandivision of tbe Dutcb company Pbilips Electronics,re-created its industrial ligbting business by sbift-ing downstream from purcbasers to infiuencers.Traditionally, tbe industry focused on corporatepurcbasing managers who bougbt on the basis ofhow much the lightbulbs cost and bow long theylasted. Everyone in the industry competed head-to-bead along those two dimensions.

Bloomberg's Value Curve at Its Debut

high on-line financial information industry

Bloomberg

m

price coverage ofprice quotes

coverageof news

terminalease of use

on-line historicalanalytics price data

Key elements of product, serwce, and delivery

lifestyleinformation

To establish its value curve, Bloomberglooked across the chain of buyers fromthe IT managers that had traditionallypurchased financial information systemsto the traders who used them. Its value

innovation stemmed from a combinationof creating new features-such as on-lineanalytic capabilities-that traders ratherthan IT managers value and raising easeof use by an order of magnitude.

88 HARVARD BUSINESS REVIEW (anuary-Febmary 1999


By focusing on influencers, including CFOs andpublic relations people, Philips came to understandthat the price and life of bulhs did not account forthe full cost of lighting. Because lamps containedenvironmentally toxic mercury, companies facedhigh disposal costs at the end of a lamp's life. Thepurchasing department never saw those costs, butCFOs did. So in 1995, Philips introduced the Alto,an environmentally friendly hulb that it promotesto CFOs and to public relations people, using thoseinfluencers to drive sales. The Alto reduced cus-tomers' overall costs and garnered companies posi-tive press for promoting environmental concerns.The new market Alto created has superior marginsand is growing rapidly; the product has alreadyreplaced more than 25% of traditional T-12 fluores-cent lamps used in stores, schools, and office huild-ings in the United States.

Many industries afford similar opportunities tocreate new market space. By questioning conven-tional definitions of who can and should he thetarget customer, companies can often see funda-mentally new ways to create value.

Looking Across ComplementaryProduct and Service OfferingsFew products and services are used in a vacuum;in most cases, other products and services affecttheir value. But in most industries, rivals convergewithin the hounds of their industry's productand service offerings. Take movie theaters as an ex-ample. The ease and cost of getting a babysitter andparking the car affect the perceived value of goingto the movies, although these complementary ser-vices are beyond the bounds of the movie theaterindustry as it has been traditionally defined. Fewcinema operators worry about how hard or costly itis for people to get babysitters. But they should, be-cause it affects demand for their business.

Untapped value is often hidden in complemen-tary products and services. The key is to define thetotal solution buyers seek when they choose a prod-uct or service. A simple way to do so is to thinkabout what happens before, during, and after yourproduct is used. Babysitting and parking the carare needed before going to the movies. Operatingand application software are used along with com-puter hardware. In the airline industry, groundtransportation is used after the flight but is clearlypart of what the customer needs to travel from oneplace to another.

Companies can create new market space by zero-ing in on the complements that detract from thevalue of their own product or service. Look at

HARVARD BUSINESS REVIEW Tanuary-February 1999

Borders Books fii. Music and Barnes & Noble in theUnited States. By the late 1980s, the U.S. retail-book industry appeared to be in decline. Americanswere reading less and less. The large chains of mallbookstores were engaged in intense competition,and the small, independent hookstore appeared tobe an endangered species.

Against this backdrop. Borders and B&N createda new format-book superstores - and woke up anentire industry. When either company enters amarket, the overall consumption of books oftenincreases by more than 50%.

The traditional business of a bookstore had beennarrowly defined as selling books. People came,they bought, they left. Borders and B6i.N, however,thought more hroadly about the total experiencepeople seek when they buy books-and what theyfocused on was the joy of lifelong learning and dis-covery. Yes, that involves the physical purchase ofbooks. But it also includes related activities: search-ing and hunting, evaluating potential purchases,and actually sampling books.

Traditional retail-book chains imposed tremen-dous inefficiencies and inconveniences on con-sumers. Their staffs were generally trained ascashiers and stock clcrks; few could help customersfind the right book. In small stores, selection waslimited, frustrating the search for an exciting title.People who hadn't read a good book review recentlyor picked up a recommendation from a friendwould be unlikely to patronize these hookstores.As a rule, the stores discouraged browsing, forcingcustomers to assume a large part of the risk in buy-ing a book, since people would not know until afterthey bought it whether they would like it. As forconsumption, that activity was supposed to occur athome. But as people's lives have hecome increasinglyharried, home has hecome less likely to be a peace-ful oasis where a person can enjoy a wonderful hook.

Borders and B&N saw value trapped in thesecomplementary activities. They hired staff withextensive knowledge of books to help customersmake selections. Many staff memhers have collegeor even advanced degrees, and all are passionatebook lovers. Furthermore, they're given a monthlybook allowance, and they're actually encouraged toread whenever business is slow.

The superstores stock more than 150,000 titles,whereas the average bookstore contains around20,000. The superstores are furnished with arm-chairs, reading tables, and sofas to encourage peoplenot just to dip into a book or two but to read themthrough. Their coffee bars, classical music, andwide aisles invite people to linger comfortably.They stay open until 11 at night, offering a relaxing


high

low

destination for an evening of quietreading, not a quick shopping stop.(See tbe graph "Value Innovation inBook Retailing.")

Book superstores redefined thescope of the service they offer. Theytransformed tbe product from thebook itself into the pleasure of readingand intellectual exploration. In lessthan six years. Borders and B&N baveemerged as tbe two largest bookstorecbains in tbe United States, witb a to-tal of more tban 650 superstores be-tween tbem.

We could cite many otber examplesof companies tbat bave followed thispath to creating new market space.Virgin Entertainment's stores com-bine CDs, videos, computer games,and stereo and audio equipment tosatisfy buyers' complete entertain-ment needs. Dyson designs its vacu-um cleaners to obliterate tbe costlyand annoying activities of buying andchanging vacuum cleaner bags. Zeneca's Salickcancer centers combine all tbe cancer treatmentstbeir patients migbt need under one roof so tbeydon't bave to go from one specialized center to an-otber, making separate appointments for eacb ser-vice tbey require.

Looking Across Functional orEmotional Appeal to BuyersCompetition in an industry tends to converge notonly around an accepted notion of tbe scope of itsproducts and services but also around one of twopossible bases of appeal. Some industries competeprincipally on price and function based largely oncalculations of utility; tbeir appeal is rational. Otberindustries compete largely on feelings; tbeir appealis emotional.

Yet tbe appeal of most products or services is rarelyintrinsically one or tbe otber. Tbe pbenomenon is aresult of the way companies bave competed in thepast, wbicb bas unconsciously educated consumerson wbat to expect. Companies' behavior affects cus-tomers' expectations in a reinforcing cycle. Overtime, functionally oriented industries become morefunctionally oriented,- emotionally oriented indus-tries become more emotionally oriented. No wondermarket research rarely reveals new insights into wbatcustomers really want. Industries bave trained cus-tomers in what to expect. When surveyed, they echoback: more of tbe same for less.

Value Innovation in Book Retailing

Borders and Barnes & Noble

independentbookstores

price knowlegeablestaff

storehours

caf^ andlounge area

Key elements of produa, service, and delivery

Borders and Barnes & Noble lookedacross complementary products andservices to establish a new valuecurve in book retailing.Their booksuperstores raised the selection of

books, the level of staff knowledge,and the range of store hours wellabove the industry standards whilelowering price and creating a whollynew reading environment.

Companies often find new market space wbentbey are willing to challenge the functional-emo-tional orientation of their industry. We bave ob-served two common patterns. Emotionally orientedindustries offer many extras tbat add price witboutenhancing functionality. Stripping those extrasaway may create a fundamentally simpler, lower-priced, lower-cost business model that customerswould welcome. Conversely, functionally orientedindustries can often infuse commodity productswith new life by adding a dose of emotion-and in sodoing, can stimulate new demand.

Look at bow Starbucks transformed a functionalproduct into an emotional one. In tbe late 1980s,General Foods, Nestle, and Procter & Gamble domi-nated tbe U.S. coffee market. Consumers drank cof-fee as part of a daily routine. Coffee was considered acommodity industry, marked hy bcavy price-cuttingand an ongoing battle for market sbare. Tbe industryhad taught customers to sbop based on price, dis-count coupons, and brand names tbat are expensivefor companies to build. Tbe result was paper-thinprofit margins and low growth.

Instead of viewing coffee as a functional product,Starbucks set out to make coffee an emotionalexperience, wbat customers often refer to as a"caffeine-induced oasis." Tbe big tbree sold a com-modity-coffee by the can; Starbucks sold a retail-ing concept-the coffee bar. The coffee bars offereda cbic gathering place, status, relaxation, conversa-tion, and creative coffee drinks. Starbucks turned

90 HARVARD BUSINESS REVIEW January-February 1999


coffee into an emotional experience and ordinarypeople into coffee connoisseurs for wbom the steep$3-per-cup price seemed reasonable. With almost noadvertising, Starbucks became a national brand witbmargins rougbly five times tbe industry average.

What Starbucks did for coffee. Swatch did for bud-get watches. Long considered a functional item,budget watches were bought merely to keep track oftime. Citizen and Seiko, the leaders in the industry,competed tbrougb advances in functionality byusing quartz technology to improve accuracy, forexample, or by making digital displays tbat wereeasier to read. Swatcb turned budget watches intofashion accessories.

SMH, tbe Swiss parent company, created a designlab in Italy to turn its watches into a fashion state-ment, combining powerful tecbnology witb fantasy."You wear a watch on your wrist, right against yourskin," explains cbairman Nicbolas Hayek. "It canbe an important part of your image. I believed thatif we could add genuine emotion to the product anda strong message, we could succeed in dominatingthe industry and creating a powerful market." BeforeSwatcb, people usually purchased only one watch.Swatcb made repeat purcbases tbe standard. InItaly, the average person owns six Swatches to fittbeir different moods and looks.

Tbe Body Sbop created new market space by shiit-ing in the opposite direction, from an emotionalappeal to a functional one. Few industries are moreemotionally oriented tban cosmetics. The industry

Is the Body Shop a Cosmetics Company?

high

low

sells glamour and beauty, hopes and dreams as muchas it sells products. On average, packaging and adver-tising constitute 8 5 % of cosmetics companies' costs.

By stripping away tbe emotional appeal, tbe BodySbop realized tremendous cost savings. Since cus-tomers get no practical value from the money tbeindustry spends on packaging, tbe Body Sbop usessimple refiUable plastic bottles. Tbe Body Shopspends little on advertising, again because its cus-tomers get no functional value from it. In short, tbeBody Sbop bardly looks like a cosmetics companyat all. Tbe company's approacb-and its emphasison natural ingredients and healthy living-was sorefreshingly simple tbat it won consumers overtbrougb common sense and created new marketspace in an industry accustomed to competing on atried-and-true formula. (See tbe grapb "Is tbe BodySbop a Cosmetics Company?")

A burst of new market creation is under way in anumber of service industries tbat are following thispattern. Relationship businesses like insurance,banking, and investing bave relied bcavily on tbeemotional bond between broker and client. Tbeyare ripe for cbange. Direct Line Insurance in Britain,for example, bas done away witb traditional bro-kers. It reasoned tbat customers would not need tbeband-bolding and emotional comfort that brokerstraditionally provide if tbe company did a better jobof, for example, paying claims rapidly and eliminat-ing complicated paperwork. So instead of usingbrokers and regional branch offices. Direct Line

substitutes information tecbnology toimprove claims bandling, and it pass-es on some of the cost savings to cus-tomers in the form of lower insurancepremiums. In tbe United States, Van-guard Group in index funds andCbarles Scbwab in brokerage servicesare doing tbe same in the investmentindustry, creating new market spaceby transforming emotionally orientedbusinesses based on personal relation-sbips into high-performance, low-costfunctional businesses.

price packaging high-tech glamorous natural representationand cosmetics image ingredients of healthy

advertising science livingKey elements of product service, and delivery

By reconsidering the traditional basisof appeal of its industry, the BodyShop created a value curve so diver-gent that it hardly looks like a cos-metics company at all. In appealing to

function rather than emotion, theBody Shop reduced price, glamour,and packaging costs while creating anew emphasis on natural ingredientsand healthy living.

HARVARD BUSINESS REVIEW lanuary-Febniary 1999

Looking Across TimeAll industries are subject to externaltrends that affect tbeir businessesover time. Think of the rapid rise ofthe Internet or tbe global movementtoward protecting tbe environment.Looking at tbese trends with the rightperspective can unlock innovationthat creates new market space.

n


Shifting the Focus of StrategyFrom Head-to-Head Competition to Creating New Market Space

The ConventionalBoundaries ofCompetition

HEAD-TO-HEAD COMPETITION CREATING NEW MARKET SPACE

Industry focuses on rivals withinits industry

Strategic group

Buyer group

Scope of productand serviceofferings

Functional-emotionalorientation ofan industry

Time

focuses on competitive positionwithin strategic group

focuses on better serving thebuyer group

focuses on maximizing thevalue of product and serviceofferings within the boundsof its industry

focuses on improvingprice-performance in linewith the functional-emotionalorientation of its industry

focuses on adapting to externaltrends as they occur

looks across substituteindustries

looks across strategic groupswithin its industry

redefines the buyer group of theindustry

looks across to complementaryproduct and service offeringsthat go beyond the bounds ofits industry

rethinks the functional-emotionalorientation of its industry

participates in shaping externaltrends over time

Most companies adapt incrementally and some-what passively as events unfold. Whether it's theemergence of new technologies or major regulatorychanges, managers tend to focus on projectingthe trend itself. That is, they ask in which directiona technology will evolve, how it will be adopted,whether it will become scalable. They pace theirown actions to keep up with the development ofthe trends they're tracking.

But key insights into new market spaces rarelycome from projecting the trend itself. Instead theyarise from business insights into how the trend willchange value to customers. By looking acrosstime-from the value a market delivers today to thevalue it might deliver tomorrow-managers canactively shape their future and lay claim to newmarket space. Looking across time is perhaps moredifficult than the previous approaches we'vediscussed, but it can be made subject to the same

disciplined approach. We're not talking about pre-dicting the future, which is inherently impossible.We're talking about finding insight in trends thatare observable today. (See the diagram "Shifting theFocus of Strategy.")

Three principles are critical to assessing trendsacross time. To form the basis of a new value curve,these trends must be decisive to your business, theymust be irreversible, and they must have a cleartrajectory. Many trends can be observed at any onetime-a discontinuity in technology, the rise ofa new lifestyle, or a change in regulatory or socialenvironments, for example. But usually only oneor two will have a decisive impact on any particu-lar business. And it may be possible to see a trendor major event without being able to predict itsdirection. In 1998, for example, the mountingAsian crisis was an important trend certain to havea big impact on financial services. But the direction

92 HARVARD BUSINESS REVIEW [anuary-February 1999


that trend would take was impossible to predict-and therefore envisioning a new value curve thatmight result from it would have been a riskyenterprise. In contrast, the euro is evolving along aconstant trajectory as it replaces Europe's multiplecurrencies. This is a decisive, irreversible, andclearly developing trend upon which new marketspace might be created in financial services.

Having identified a trend of this nature, managerscan then look across time and ask themselves whatthe market would look like if the trend were takento its logical conclusion. Working hack from thatvision of a new value curve, they can then identifywhat must be changed today to unlock superiorvalue for buyers.

Consider Enron, an energy company based inHouston, Texas. In the 1980s, Enron's businesscentered on gas pipelines. Deregulation of the gasindustry was on the horizon. Such an event wouldcertainly he decisive for Enron. The U.S. govern-ment had just deregulated the telecom and trans-portation industries, so a reversal in its intent toderegulate the gas industry was highly unlikely.Not only was the trend irreversible, its logicalconclusion was also predictable-the end of pricecontrols and the breakup of local gas monopolies.By assessing the gap between the market as it stoodand the market as it was to he, Enron gained insightinto how to create new market space.

When local gas monopolies were broken up, gascould be purchased from anywhere in the nation.At the time, the cost of gas varied dramaticallyfrom region to region. Gas was much more expen-sive, for example, in New York and Chicago than itwas in Oregon and Idaho. Enron saw that deregula-tion would make possible a national market inwhich gas could be bought where it was cheap andsold where it was expensive. By examining how thegas market could operate with deregulation, Enronsaw a way to unlock tremendous trapped value on anational scale.

Accordingly, Enron worked with governmentagencies to push for deregulation. It purchased re-gional gas-pipeline companies across the nation,tied them together, and created a national marketfor gas. That allowed Enron to buy the lowest costgas from numerous sources across North Americaand to operate with the hest spreads in the industry.Enron became the largest transporter of natural gasin North America, and its customers benefitedfrom more reliable delivery and a drop in costs of asmuch as 40%.

Cisco Systems created a new market space ina similar way. It started with a decisive and irre-versible trend that had a clear trajectory; the growing

HARVARD BUSINESS REVIEW January-February 1999

demand for high-speed data exchange. Ciscolooked at the world as it was-and that world washampered hy slow data rates and incompatiblecomputer networks. Demand was exploding as,among other factors, the number of Internet usersdoubled roughly every ioo days. So Cisco couldclearly see that the problem would inevitablyworsen. Cisco's routers, switches, and other net-working devices were designed to create break-through value for customers, offering fast dataexchanges in a seamless networking environment.Thus Cisco's insight is as much about value inno-vation as it is about technology. Today more than80% of all traffic on the Internet fiows throughCisco's products, and its margins in this new mar-ket space are in the 60% range.

Regenerating Large CompaniesCreating new market space is critical not just forstart-ups but also for the prosperity and survivalof even the world's largest companies. Take Toyotaas an example. Within three years of its launchin 1989, the Lexus accounted for nearly one-thirdof Toyota's operating profit while representingonly 2% of its unit volume. Moreover, the Lexushoosted Toyota's brand image across its entire rangeof cars. Or think of Sony. The greatest contributionto Sony's profitable growth and its reputation inthe last 20 years was the Walkman. Since its intro-duction in 1979, the Walkman has dominated thepersonal portable-stereo market, generating a hugepositive spillover effect on Sony's other lines ofbusiness throughout the world.

Likewise, think of SMH. Its collection of watchcompanies ranges from Blancpain, whose watchesretail for over $200,000, to Omega, the watch ofastronauts, to midrange classics like Hamilton andTissot to the sporty, chic watches of Longinesand Rado. Yet it was the creation of the Swatch andthe market of fun, fashionable watches that revi-talized the entire Swiss watch industry and madeSMH the darling of investors and customers theworld over.

It is no wonder that corporate leaders throughoutthe world see market creation as a central strategicchallenge to their organizations in the upcomingdecade. They understand that in an overcrowdedand demand-starved economy, profitable growth isnot sustainable without creating, and re-creating,markets. That is what allows small companies tohecome big and what allows big companies to re-generate themselves. ^

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