Continuing in our series which takes a closer look at each step in the Blue Ocean strategic sequence, our focus advances to the fourth step — streamlining and cost innovations. Once featured, each step is made accessible through the Blue Ocean Strategy Basics archive of this site. For the fourth step, we turn to pages 132 — 133 of the book Blue Ocean Strategy (co-authored by Professor W. Chan Kim and Professor Renée Mauborgne):
To hit the cost target, companies have three principal levers. The first involves streamlining operations and introducing cost innovations from manufacturing to distribution. Can the product’s or service’s raw materials be replaced by unconventional, less expensive ones — such as switching from metal to plastic or shifting a call center from the U.K. to Bangalore? Can high-cost, low-value-added activities in your value chain be significantly eliminated, reduced, or outsourced? Can the physical location of your product or service be shifted from prime real estate locations to lower-cost locations, as The Home Depot, IKEA, and Wal-Mart have done in retail or Southwest Airlines has done by shifting from major to secondary airports? Can you truncate the number of parts or steps used in production by shifting the way things are made, as Ford did by introducing the assembly line? Can you digitize activities to reduce costs?
By probing questions such as these, the Swiss watch company Swatch, for example, was able to arrive at a cost structure some 30 percent lower than any other watch company in the world. At the start, Nicolas Hayek, chairman of Swatch, set up a project team to determine the strategic price for the Swatch. At the time, cheap (about US$ 75), high precision quartz watches from Japan and Hong Kong were capturing the mass market. Swatch set the price at US$ 40, a price at which people could buy multiple Swatches as fashion accessories. The low price left no profit margin for Japanese or Hong Kong-based companies to copy Swatch and undercut its price. Directed to sell the Swatch for that price and not a penny more, the Swatch project team worked backwards to arrive at the target cost, a process that involved determining the margin Swatch needed to support marketing and services and earn a profit.
Given the high cost of Swiss labor, Swatch was able to achieve this goal only by making radical changes in the product and production methods. Instead of using the more traditional metal or leather, for example, Swatch used plastic. Swatch’s engineers also drastically simplified the design of the watch’s inner workings, reducing the number of parts from one hundred fifty to fifty-one. Finally, the engineers developed new and cheaper assembly techniques; for example, the watch cases were sealed by ultrasonic welding instead of screws. Taken together, the design and manufacturing changes enabled Swatch to reduce direct labor costs from 30 percent to less than 10 percent of total costs. These cost innovations produced a cost structure that is hard to beat and let Swatch profitably dominate the mass market for watches, a market previously dominated by Asian manufacturers with a cheaper labor pool.
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