Blue Ocean Strategy

This is the name of a popular book published about 5 years ago that helped improve how the top management of many companies think and how they should come out with strategies to help their company grow.

I started reading this year (yeah, I know...) and found some intriguing ideas that I thought I should share it here. Here are some of those that would really help investors when they do some analysis on companies.

1. Blue Ocean Strategy simply refers to innovations that companies come out with that separate them from the competition. The strategies centre on creating uncontested market space, new demands which was non-existent in the current world (red ocean). This can be done by reconstructing market boundaries by focusing on value-add to end users, combining virtues of different but competing industries or simply creating a new product. The strategy also involve reducing current cost structure while creating new demand thereby helping grow both the topline and the bottom line at the same time.

Some well-known examples of Blue Ocean Strategies would be:

Apple's iPhone (redefining value-add to users)
Apple's iPad (new product, new market)
Nintendo's Wii (expansion of gaming to non-core gamers)
Cirque du Soleil (combining virtue of circus and art)
NetJets (value add of both private jet and commercial airline)
Berries (focusing on fun-to-learn Chinese for English-speaking kids)

2. According to the book, blue ocean strategies are usually not created by new players in the market, nor by technology, nor by big companies. Most companies never continuously come up with blue ocean strategies. The unit of analysis, then, is not a company, nor industry, nor change in technology. The most appropriate unit of analysis is therefore the strategies.

3. Blue Ocean ultimately becomes Red Ocean as competitors catch up. Fat profit margins eventually go down and the whole industry succumb to volume and price competition. ie pursuing profit increase by growing the revenue (usually targeting only single digit improvement) and/or reducing price (by reducing cost and passing on this benefit to clients).

For investors, we should always try to look for companies that are going into wonderful Blue Oceans which they are creating. Companies with strategies venturing in the Blue Ocean ultimately enjoy huge profit growth that are not factored in by the markets. However it may not be easy identifying such companies, hence it is still important to look at the valuation of the stock while betting on Blue Ocean.

This means that as value investors, we cannot buy a Blue Ocean company when the PE is 20x. It goes against the grain of value investing. What if the Blue Ocean turns out to be only a 1 yr phenomenon, then we are pretty screwed bcos when we bought at 20x, and the market is usually discounting a few good years ahead. A good investment strategy would probably be buying into a cheap stock with potential to unlock a Blue Ocean.

However we must also be cognizant that Blue Oceans will ultimately become Red Oceans. Blue Ocean stocks probably see their intrinsic value explodes in the first few years but later plateau out or even decline. This is in contrast with the fantastic Dividend Aristocrats whereby the intrinsic value simply rises over time usually for decades.