Differenciation
strategy
Product differenciation
is a competitive business strategy whereby firms
attempt to gain a competitive advantage by increasing
the perceived value of their products and services
relative to the perceived value of other firm's
products and services.
Products sold by two different
firms may be exactly the same, but if customers
believe the first is more valuable than the second,
then the first product has a differentiation advantage.
The existence of product differentiation, in the
end, is always a matter of customer perception
but firms can take a variety of actions to influence
these perceptions.
Objective
Incorporate differentiating
features that will cause buyers to prefer the
company's product/service over the brands of
rivals. A firm pursuing such a strategy thus
focuses on higher revenues/margins for achieving
enhanced economic performance.
The challenge
Finding ways to differenciate
-
- NOT EASILY COPIED
or MATCHED by rivals
Anything a company can do to create
value for buyers represents a potential basis
for differenciation.
Ways firms can differentiate
their products / services
A way in which firms can attempt
to influence customer perceptions is to modify
the objective properties of the products or
services they sell.
- Linkage between functions
The way to differentiate
products is through linking different functions
within the firm. For example in linking the
sales and service function.
Introducing a product at the
right time can help create product differentiation.The
issue is to be the first mover to introduce
a new product before all other firms. First
movings is an important determinant of perceived
diffenrences in the quality of education.
For example, the Ecole Hôtelière
de Lausanne, founded in 1893, is perceived
as more prestigious than more recently founded
schools for hospitality industry education.
The physical location of a firm
can also be a source of product differentiation.
If a firm is located close to customers, or
in a location that is easy for customers to
get to, it may have a product differentiation
advantage compared to the other firms.
The mix of products or services
sold by a firm can be a source of product
differentiation.
For example, HP discovered in
1960' that its customers were purchasing HP
instruments and attaching them with cables
made by other firms to computers made by other
firms. The value of these instruments, in
combinaison with cables and computers, was
greater than the value of instruments, cables
and computers sold separately.
A second kind of linkage
among a mix of products : many customers prefer
to go to one location, to shop at several
stores at one, rather than traveling to a
series of locations to shop. This one-stop
shopping reduces travel time and cost.The
value of several stores brought together in
a particular location is greater than the
value of those stores if they were isolated.
Another basis of product differentiation
is linkages between one firm's products and
the products or services of other firms. For
example, links between credit card companies
with car rental firms or Insurance companies.
One of the most powerful
bases of product differentiation is the reputation
of a firm and of its products. Reputation
is often very difficult to to develop. However,
once developed, it tends to last a long time,
even if the basis for a firm's reputation
no longer exists. In the end, the ability
of a firm to develop, maintain and improve
its reputation depends on customer experiences
with that firm's products and services.
Products are differentiated
in the extent to which they are customized
for particular customer applications.
Products have been differentiate
on the basis of alternative distribution channels.
For example, Coca-Cola distributes its drinks
through a network of independent and company-owned
bottlers. Coca-Cola manufactures key ingredients
for its soft drinks and ship these ingredients
to local bottlers, who add carbonated water,
package the drinks in cans or bottles, and
distribute the final product to soft-drink
outlets in a given geographic area.
Products have been differentiated
by the level of service and support associated
with them. For example, some firms have not
developed their own service and support and
rely on a network of independent service and
support operations.
Two techniques for studying
the bases of product differentiation :
- Multidimensional
Scaling : it is a technique
for analyzing the perceived similarity of
a set of products or services (A, B, C, D,
E & F). It is a pure inductive method
for describing the bases of product differentiation
in an industry.
- Regression Analysis
of the determinants of product price
is a more deductive approach to the empirical
analysis of bases of product differentiation.
In this approach, the analyst
proposes a wide range of characteristics that
may have an impact on a product's price.For
example, in automobiles, product attributes
such as engine displacement (A1), passenger
room (A2), trunk size (A3), perceived quality
(A4), acceleratrion (A5) and braking (A6)
capabilities may all have an impact on the
price of a car.
Price
= f {Bo + B1A1+B2A2+B3A3+B4A4+B5A5+B6A6 }
Bo : constant ;
B1 to B6 : regression coefficients ; A1 to A6
: independant variables
Product differenciation and
economic performance
Economically valuable bases of
product differentiation can enable a firm to
increase its revenues, neutralize threats and
exploit opportunities.
Under perfect
competition, firms face a horizontal
demand curve and they maximize their economic
performance by producing and selling output
such that marginal revenue equals maginal costs.
When demand is a horizontal curve, price = average
revenue = marginal revenue. See also Cost
leadership strategy
When firms sell differentiated
products, they gain some ability to adjust their
prices. A firm can sell its output at very high
prices and produce relatively smaller amounts
of output, or it can sell its output at very
low prices and produce relatively greater amounts
of output. These tradeoffs between price and
quantity produced suggest that firms selling
differentiated products face a downward-sloping
demand curve, rather than a horizontal demand
curve for firms in a perfect competitive market.
Firms selling differentiated products
and facing a downward-sloping demand curve are
in an industry structure described as monopolistic
competition (Chamberlin). This means
that the industry is not perfectly competitive
and that a firm has some control over the prices
it will charge for its products.
The four curves below (demand,
marginal revenue, marginal cost, average total
cost) can be used to determinate the level of
economic profit for a firm under monopolistic
competition.
When (MR = MC), the firm maximizes
its profit by producing an output situated between
3 and 4 units.The price the firm can charge
at this optimal point depends on the demand
it faces for its differentiated product. Maximum
Profit = (Price - ATC) x Quantity.
The existence of above-narmal
economic profits motivates entry
into an industry. In monopolistically competitive
industries, such entry means that the demand
curve facing incumbents firms shifts downward
and to the left. That implies that an incumbent
firm's customers will buy less of its output
if it maintains its prices or that a firm will
have to lower its prices to maintain its current
volume fo sales.
The ability of a firm to
market a differentiated product, and
obtain above-normal economic profits, depends
on that product either neutralizing
threats or exploiting opportunities
(External
Environmental Analysis). The ability
of a firm to maintain its competitive
advantage depends, in turn, on the rareness
and imitability of its organizational
strengths and weaknesses
(Internal
Environmental Analysis).
External Environmental
Threats
A successful differenciation
strategy creates a lines of defense against
the five
competitive forces identified
by Porter : rival competitors, buyers, suppliers,
potential entrants, substitutes.
Threats of potential entrants
For example, product differentiation
helps reduce the threat of new entry by forcing
potential entrants to an industry to absorb
not only the standard costs of beginning business
but also the additional costs associated with
overcoming incumbent firms' product differentiation
advantages
Threat of rivalry
Product differentiation reduces
the threat of rivalry, because each firm in
an industry attempts to carve out its own
unique product niche. Rivalry is not reduced
to zero, for these products still compete
with one another for a common set of customers,
but it is somewhat attenuated, because the
customers each firm seeks are different.
Threat of substitutes
Product differentiation also
helps firms reduce the threat of substitutes
by making a firm's current products appear
more attractive than substitute products.
For example, fresh food
can be thought of as a substitute for frozen
processed foods
Threat of suppliers
Product differentiation can
also reduce the threat of suppliers.
Powerful suppliers can raise
the prices of the products or services they
provide.
Often, these increased supply
costs must be passed on to a firm's customers
in the form of higher prices.
A firm without
a highly differentiated product may
find it difficult to pass its increased costs
on to customers, since these customers will
have numerous other ways to purchase similar
products or services from a firm's competitors.
However, a firm with a highly
differentiated product may have loyal customers
or customers who are unable to purchase similar
products or services from other firms. These
types of customers are more likely to accept
increased prices due to a firm passing on
increased costs caused by a powerful supplier.
Thus a powerful supplier may be able to raise
its prices, but these increases often do not
reduce the profitability of a firm selling
a highly differentiated product.
Of course, the ability of a
firm selling a highly differentiated product
to be somewhat immune from powerful suppliers
may actually encourage suppliers to exercise
their power. Since firms can pass increased
costs on to customers, suppliers may decide
to increase costs. At some point, even the
most loyal customers of the most differentiated
products or services may find a firm's prices
too high. These price barriers suggest a limit
to a firm's ability to raise prices. Any increase
in supply costs once these barriers are reached
results in reduced economic profits for a
firm.
However, at these price and
supply-cost levels, a firm may find it possible
to obtain substitute supplies, or other firms
may have entered into the supply market. The
existence of substitute supplies
or more suppliers both attenuates the power
of suppliers and enables a firm selling a
differentiated product to maintain positive
economic profits
Threat of buyers
Finally, product differentiation
can reduce the threat of buyers. When a firm
sells a highly differentiated product, it
enjoys a quasi-monopoly in that segment of
the market. Buyers interested in purchasing
this particular product must buy it from a
particular firm. Any potential buyer power
is reduced by the ability of a firm to withhold
highly valued products or services from a
buyer.
External Environmental
Opportunities
Product differentiation can
also help a firm take advantage of environmental
opportunities.
In fragmented industries
In fragmented industries,.firms
with highly differentiated products or services
may be able to use this product position to
help consolidate the industry. For example,
in the highly fragmented commercial printing
business, a national advertising campaign
emphasizing quality printing and fast service
has enabled Postal Instant Printing (PIP)
to gain a large share of this fragmented market.
In emerging industries
By being a first mover in these
industries, firms can gain product differentiation
advantages based on perceived technological
leadership, preemption of strategically valuable
assets, and buyer loyalty due to high switching
costs.
In mature industries
ln mature industries product
differentiation efforts often switch from
attempts to introduce radically new technologies
to product refinement as a basis of product
differentiation.
For example,
in the mature retail gasoline market, firms
attempt to differentiate their products not
by introducing radically new gasolines but
rather by introducing slightly modified gasolines
(cleaner-buming gasoline, gasoline that cleans
fuel injectors, and so forth)
In declining industries
Product differentiation can
also be an important strategic option in a
declining industry. Product differentiating
firms may be able to become leaders in this
kind of industry (based on their reputation,
on unique product attributes, or on some other
product differentiation basis). Altematively,
highly differentiated firms may be able to
discover a viable market
niche that will enable them to
survive despite the overall decline in the
market.
In a global industry
Finally, the decision to implement
a product differentiation strategy can have
a significant impact on how a firm acts in
a global industry. ln general, product differentiation
requires a firm to be in close contact with
its customers, to understand their idiosyncratic
needs and how those needs can be addressed
in a firm's products or services.
Global strategies, where business
functions are located in ways that minimize
functional costs, may make it relatively difficult
for a firm to dilierentiate its products or
services in ways that are needed by different
local markets. A multinational strategy, where
different market segments throughout the world
are serviced by quasi-independent operating
divisions, may enable a firm to differentiate
its products in ways that respond to local
market needs.
Rareness of product
differentiation
The concept of product differentiation
generally assumes that the number of firms
that have been able to differentiate their
products in a particular way is, at some point
in time, less than the number of firms needed
to generate perfect
competition dynamics.
Highly differentiated firms
can charge a price for their product that
is greater than average total cost.
The rareness of a product differentiation
strategy depends on the ability of individual
firms to be creative. Highly creative firms
will be able to discover or create new ways
to differentiate their products or services.
These kinds of firms will always be one step
ahead of the competition.
Imitability
of product differentiation
Valuable and rare bases of product
differentiation must be costly to imitate
or duplicate if they are to be sources of
sustained competitive advantage.
Why differenciators
should know about game theory ?
A differenciated product
strategy is also valuable if competitors are
not likely to follow a similar approach. If
tthey do so, this will lead to a win-win situation
(game
theoretic analysis needed).
Organizing forsustained
product differentiation advantage
Organizational structure, management
control systems, and compensation policies
must be consistent with a firm's product differentiation
efforts if a firm is to realize the full potential
of those efforts.
Whereas the organizational requirements
for a cost-leadership strategy focus on reducing
costs in developing and manufacturing products,
the organizational requirements for a product
differentiation strategy emphasize innovativeness,
creative flair, and related marketing abilities.
Commonly required skills
and resources :
- strong marketing abilities
- product engineering
- creative flair
- corporate reputation for
quality or technological leadership
- strong cooperation from channels
Common organizational
requirements
:
- strong coordination among
functions
- subjective measurement and
incentives
- amenities to attract highly
skilled labor, scientists, or creative people
Risks of differenciation
- The cost of differenciation
becomes too great
- Buyers become more sophisticated
and need for differenciation falls
- Imitation narrows perceived
differenciation
From Low-Cost Strategy to
Product Differentiation Strategy
| |
Product
differentiators |
Low-cost
firms |
| Share
of Market |
Low |
Large |
| Price |
High |
Low |
Sources
:
Strategic Management, Raphael Amit, Professor at Wharton University of Pennsylvania, US
Strategy formulation and implementation: Tasks of the General Manager, by Arthur A. Thompson, Jr & A.J. Strickland III, 1992
Competitive Advantage, Michael E. Porter, 1985
Competitive Strategy, Michael E. Porter (1980) and Thompson & Strickland (1992)
Gaining and Soustaining Competitive Advantage, Jay. B. Barney, Addison-Wesley, 1997
Contemporary Strategic Analysis, Robert M. Grant, 3th edition, Blackwell, 1998
© ECOFINE - Bernard Jaquier, Professor Emeritus & Dr Honoris Causa, Lausanne, Switzerland, 2020
