From: Vancouver, BC
I can not claim to be an expert in naval tactics and have learned a few hard lessons at sea from my opponents in my recent MP games. But let me offer a few observations about naval power in the game.
First, the naval war is secondary to the land war. Just accept that. To defeat a major power, you have to capture all its capitals or drive its national morale to zero. The naval war can help with the latter but the only major power which can in theory be forced to surrender through naval power alone is the UK (and that is extremely unlikely). I agree that the game is very land focussed but so was WW1. In general, there is far more naval combat in the game than there actually was in the war. A more realistic depiction of naval combat would require simultaneous movement - which would need an entirely different game system.
It is true that few players build capital ships during the game, since they are expensive and take a very long time to complete. But both sides receive significant reinforcements of capital ships during the war and there are lots of reasons to build or rebuild units like destroyers, subs, seaplane carriers which only take 6 turns to complete. Torpedo boats take only 3 turns and are very cheap. I would not support obliging players to devote a portion of their MPP production to navies: different powers have different needs at various phases in the war. But if you want to make that a house rule, try it out against an opponent who is willing to give it a go and see what happens.
As I see it, naval power can aid the land war and contribute to victory by your side in a number of different ways:
At the strategic level, naval power can raid enemy convoys, disrupt enemy production by occupying the red hatched hexes, and degrade enemy ports by blockading them. All of these actions reduce the enemy's production of MPPs - the key strategic resource in the game. The UK, as an island nation, is the most vulnerable to this kind of enemy naval activity (which is why it has the largest navy), but Germany, France, Italy, Serbia and even the Ottomans can have their MPPs reduced to some degree by naval activity; and every power except Serbia has some naval capability.
Also at the strategic level, naval combat can significantly drive down enemy national morale and increase your own, because lost ships count for double NM points both for the attacker and against the defender. In my last couple of games, the Germany has pushed Russian NM below 25%, triggering the first revolution and Lenin's arrival, largely by destroying the Russian Baltic fleet.
Finally, there is a the strategic pressure on national morale that the Entente can place on Germany by occupying the NM hexes in the North Sea and the North Atlantic; and in return, if Germany can pull it off, the heavy NM hits they can inflict on the UK by occupying the British NM hexes west of Britain and Ireland. The Entente blockade is gradual but relentless, especially if sustained over several years; a German counter-thrust against the British NM hexes does much quicker damage and if sustained for two turns or more, will shut down key British ports, thus disrupting essential convoys; but it comes with the strategic offset of driving the United States much faster into mobilizing for the Entente.
At the tactical level, naval power can support the land war by sinking enemy transports, or protect against those attacks. There is no easier way of killing an enemy corps - at full MPP and NM cost - than by sinking it on a transport. Naval superiority along an enemy coastline can either open it up to amphibious landings, or protect against that. Shore bombardment can reduce the morale of enemy units on coastal hexes. Finally, sea-plane carriers can be valuable and flexible source of spotting capability both on land and at sea.
The game also offers a number of different theatres for naval warfare. First there are the enclosed or semi-enclosed seas: the Adriatic, the Baltic and the Black Sea. The naval warfare can be intense in the Adriatic and the Baltic, where the Central Powers and the Entente have roughly inverse positions of superiority. The Black Sea tends to be quieter, since the opposing navies are much smaller and Russo-Turkish land war is usually entirely conducted inland in the Caucasus, but there is some scope for surprises if either side ventures an amphibious invasion across the Black Sea.
Then there are the two large seas: the North Sea and the Mediterranean. Naval combat in the North Sea tends is driven the strategic action along the blockade lines against Germany, or German action moving through the North Sea to attack the U.K supply lines in the Atlantic. The Mediterranean has everything: convoy lines to raid, islands and colonies in North Africa that can only be reinforced by transports, ports that can be blockaded and defensive positions to bombard. It is usually a zone of intense naval combat between the secondary naval powers in the game: Austria-Hungary and to some degree the Ottomans, versus the French, the Italians and part of the UK fleet.
Finally, there is the Atlantic, which for most of the war is a theatre for pure strategic warfare between the German submarine fleet versus the blockading British and French navy; but there can be some interesting tactical skirmishes if the German subs are able to attack American transports late in the war.
In terms of fleet composition, there is a kind of rock/paper/scissors dynamic at work: subs are great against capital ships - the bigger the better; destroyers and torpedo boats are very effective against subs; which in turn can be easily sunk by capital ships. In varying degrees, both sides need all three of these types of naval units.
In terms of naval tactics, spotting is the most critical variable: if the enemy knows where you are and can strike first, there is significant first-mover advantage. After that, naval combat is relatively straight-forward contest between firepower and morale, since terrain and command factors do not apply at sea, few units (usually only subs and destroyers) have one point or more of experience, and supply (except against subs far from home port) is a residual factor. My sense is that advanced naval tactics employ bluff and surprise, play the odds in terms of possible changes in weather and make very creative use of naval mines (a topic which is worth a thread on its own).
Finally, the inter-play between naval power and airpower is one dimension of the game that I have only recently come to appreciate. Airships can be hugely effective spotting over sea. Maritime bombers operating from land can score useful hits on subs and surface vessels and are great at spotting too. And recon bombers, if upgraded with naval weapons, can inflict heavy blows against enemy surface ships close to shore.
In sum, there are a lot of things you can do with navies if you use your imagination. Don't leave them cowering in port!