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Category Creation Is the Ultimate Growth Strategy

November 24, 2011

Laird Hamilton is my hero. He’s not only one of the world’s best big-wave surfers but he also created an entirely new category within the sport called tow-in surfing.

The innovation came about because Laird aspired to surf a deepwater reef break on the north shore of Maui called Peahi, or Jaws, where waves can reach 120 feet high. Normally humans can’t paddle fast enough to catch waves even half that size. So Laird gathered some friends and used jet skis to transform surfing into a team sport. In tow-in surfing, one person mans a jet ski and slingshots the surfer into the wave. A third person mans a second jet ski, standing by to rescue either person.

Having grown up in Hawaii, I have the utmost respect for Laird as a waterman. But as a growth strategist, I really respect his ability to create a new category within his sport. While I’ve helped many clients grow their products, brands, and overall businesses, there is nothing as exhilarating as helping a company create an entirely new category.

Category creation goes beyond innovation, in that the new category shares roots with its original product class but delivers such exponentially better benefits, experience, and economics that the new category graduates from its original product class. Another telltale sign of category creation is that it comes with a distinctive business model and profit model.

Few growth strategies match the economics of category creation. Our analysis showed the top 20 firms in Fortune‘s 2010 list of fastest-growing companies received $3.40 in incremental market capitalization for every $1.00 of revenue growth. Half the top 20 companies grew via category creation. Wall Street exponentially rewards the category creation companies, giving them $5.60 in incremental market capitalization for $1.00 in revenue growth.

Consider how category creation has helped drive revenue increases in the U.S. coffee sector.

According to the USDA, U.S. per capita coffee consumption has nearly halved from 41.2 gallons per person per year in 1950 to 24.6 in 2004. Yet total U.S. coffee sector revenue grew from $28 billion in the late 1990s to $47 billion in 2010. That means people are drinking less coffee but paying more for it — and much of this can be attributed to category creation.

Part of the credit goes to Starbucks, of course, which during the 1990s reinvented the coffeehouse concept by creating the category of infinitely customizable espresso-based beverages.

But coffee has seen other innovations, too. Just as Howard Schultz was changing the way people consumed coffee outside their homes, Keurig was reinventing the way they brewed the drink at work and at home by creating a convenient proprietary system for brewing single servings using premeasured, sealed coffee capsules.

Starbucks and Keurig share two essential qualities that are typical in category creators:

1. They captivated their consumers with significantly better benefits, experiences, and economics. Starbucks delivered not just high-quality coffee but personalization, badge value, and an affordable luxury experience. Keurig delivered high-quality, speedy, and easy coffee via a sleek brewer with the widest variety of flavors at a price that while higher than traditional brewed-at-home coffee, was still a value relative to Starbucks in the recent recession.

2. They conquered competitors with clever combinations of business and profit models.
In addition to selling frothy coffee drinks, Starbucks has branched into selling branded coffee in supermarkets and has even experimented with selling books and CDs, both of which help drive trip frequency and chances to buy coffee and coffee drinks throughout the day. Much of Keurig’s success comes from its superior brewer technology and wide variety of K-Cups. But one of the keys to success was its strength in the B2B office coffee market, which allowed the company to refine its offer and build awareness before winning in the B2C market. Several other category creators won in B2B first, then went to B2C: consider, for example, Gatorade and Under Armour, which built their businesses by selling to pro and NCAA athletes and teams and got their implicit endorsement before becoming big consumer brands.

These lessons may prove helpful to current companies. One wonders if RIM’s struggles today are a result of its BlackBerry making a huge splash in the B2B market but then not fully optimizing its consumer offer to successfully jump to the B2C market, especially when many consumers want just one device. Category creation requires innovation teams to re-think their role beyond just creating new products and services. Corporate development groups may have to accept that EBITDA multiple valuations may not be appropriate when buying a category creator.

Beyond the economics, category creation may be the most fun you can have in business. Here’s to all the Laird Hamiltons out there looking to surf the unsurfable. I raise my cup of Kona coffee to you.

Eddie Yoon

Eddie Yoon is a principal at The Cambridge Group.

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