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.

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
y y

That create value for buyers and that are 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

Product features

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

it may have a product differentiation advantage compared to the other firms.The value of several stores brought together in a particular location is greater than the value of those stores if they were isolated. A second kind of linkage among a mix of products : many customers prefer to go to one location. rather than traveling to a series of locations to shop. y Location / convenience The physical location of a firm can also be a source of product differentiation. The issue is to be the first mover to introduce a new product before all other firms. in combinaison with cables and computers. If a firm is located close to customers. y Timing Introducing a product at the right time can help create product differentiation.The way to differentiate products is through linking different functions within the firm. For example. This one-stop shopping reduces travel time and cost. to shop at several stores at one. or in a location that is easy for customers to get to. For example in linking the sales and service function. y Links with other firms . 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. was greater than the value of instruments. y Product mix The mix of products or services sold by a firm can be a source of product differentiation. The value of these instruments. First moving is an important determinant of perceived diffenrences in the quality of education. cables and computers sold separately.

y Reputation One of the most powerful bases of product differentiation is the reputation of a firm and of its products. links between credit card companies with car rental firms or Insurance companies. Reputation is often very difficult to to develop. some firms have not developed their own service and support and rely on a network of independent service and support operations. who add carbonated water. it tends to last a long time. For example. For example.Another basis of product differentiation is linkages between one firm's products and the products or services of other firms. even if the basis for a firm's reputation no longer exists. For example. y y y Product complexity / sophistication Consumer marketing Distribution channels Products have been differentiate on the basis of alternative distribution channels. y Product customization Products are differentiated in the extent to which they are customized for particular customer applications. once developed. Two techniques for studying the bases of product differentiation : . maintain and improve its reputation depends on customer experiences with that firm's products and services. In the end. the ability of a firm to develop. package the drinks in cans or bottles. Coca-Cola distributes its drinks through a network of independent and companyowned bottlers. and distribute the final product to soft -drink outlets in a given geographic area. Coca-Cola manufactures key ingredients for its soft drinks and ship these ingredients to local bottlers. y Service and support Products have been differentiated by the level of service and support associated with them. However.

Maximum Profit = (Price .ATC) x Quantity. price = average revenue = marginal revenue. 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 price the firm can charge at this optimal point depends on the demand it faces for its differentiated product. . the firm maximizes its profit by producing an output situated between 3 and 4 units. When (MR = MC). rather than a horizontal demand curve for firms in a perfect competitive market. neutralize threats and exploit opportunities. The four curves below (demand. or it can sell its output at very low prices and produce relatively greater amounts of output. they gain some ability to adjust their prices. It is a pure inductive method for describing the bases of product differentiation in an industry. y Regression Analysis of the determinants of product price is a more deductive approach to the empirical analysis of bases of product differentiation. firms face a horizontal demand curve and they maximize their economic performance by producing and selling output such that marginal revenue equals maginal costs. Product differenciation and economic performance Economically valuable bases of product differentiation can enable a firm to increase its revenues. average total cost) can be used to determinate the level of economic profit for a firm under monopolistic competition. When firms sell differentiated products. marginal cost. These tradeoffs between price and quantity produced suggest that firms selling differentiated products face a downward-sloping demand curve.y Multidimensional Scaling : it is a technique for analyzing the perceived similarity of a set of products or services. Under perfect competition. A firm can sell its output at very high prices and produce relatively smaller amounts of output. When demand is a horizontal curve. Firms selling differentiated products and facing a downward-sloping demand curve are in an industry structure described as monopolistic competition (Chamberlin). marginal revenue.

but it is somewhat attenuated. in turn. Rivalry is not reduced to zero. buyers. such entry means that the demand curve facing incumbents firms shifts downward and to the left. and obtain above-normal economic profits. The ability of a firm to market a differentiated product. on the rareness and imitability of its organizational strengths and weaknesses (Internal Environmental Analysis). 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. potential entrants. Threat of substitutes . Threats of potential entrants For example. External Environmental Threats A successful differenciation strategy creates a lines of defense against the five competitive forces identified by Porter: rival competitors.The existence of above-narmal economic profits motivates entry into an industry. depends on that product either neutralizing threats or exploiting opportunities (External Environmental Analysis). suppliers. because each firm in an industry attempts to carve out its own unique product niche. The ability of a firm to maintain its competitive advantage depends. In monopolistically competitive industries. because the customers each firm seeks are different. for these products still compete with one another for a common set of customers. 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. substitutes.

Often. A firm without a highly differentiated product may find it difficult to pass its increased costs on to customers. These types of customers are more likely to accept increased prices due to a firm passing on increased costs caused by a powerful supplier. At some point. even the most loyal customers of the most differentiated products or services may find a firm's prices too high. suppliers may decide to increase costs. At these price and supply-cost levels. Thus a powerful supplier may be able to raise its prices. or other firms may have entered into the supply market. For example. these increased supply costs must be passed on to a firm's customers in the form of higher prices.Product differentiation also helps firms reduce the threat of substitutes by making a firm's current products appear more attractive than substitute products. The existence of substitute . Any increase in supply costs once these barriers are reached results in reduced economic profits for a firm. Since firms can pass increased costs on to customers. 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. since these customers will have numerous other ways to purchase similar products or services from a firm's competitors. but these increases often do not reduce the profitability of a firm selling a highly differentiated product. 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 price barriers suggest a limit to a firm's ability to raise prices. a firm may find it possible to obtain substitute supplies. Powerful suppliers can raise the prices of the products or services they provide. 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.

. 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. In emerging industries By being a first mover in these industries. Buyers interested in purchasing this particular product must buy it from a particular firm. 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. and buyer loyalty due to high switching costs. firms with highly differentiated products or services may be able to use this product position to help consolidate the industry. preemption of strategically valuable assets. In fragmented industries In fragmented industries. External Environmental Opportunities Product differentiation can also help a firm take advantage of environmental opportunities. firms can gain product differentiation advantages based on perceived technological leadership. it enjoys a quasi-monopoly in that segment of the market. For example. in the highly fragmented commercial printing business.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 Product differentiation can reduce the threat of buyers. Any potential buyer power is reduced by the ability of a firm to withhold highly valued products or services from a buyer. When a firm sells a highly differentiated product.

In a global industry The decision to implement a product differentiation strategy can have a significant impact on how a firm acts in a global industry. where different market segments throughout the world are serviced by quasi-independent operating divisions. may make it relatively difficult for a firm to dilierentiate its products or services in ways that are needed by different local markets. on unique product attributes. Highly differentiated firms can charge a price for their product that is greater than average total cost. . less than the number of firms needed to generate perfect competition dynamics. Altematively. gasoline that cleans fuel injectors. at some point in time. Global strategies. may enable a firm to differentiate its products in ways that respond to local market needs. product differentiation requires a firm to be in close contact with its customers. ln general. A multinational strategy. 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. to understand their idiosyncratic needs and how those needs can be addressed in a firm's products or services. Product differentiating firms may be able to become leaders in this kind of industry (based on their reputation. 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. where business functions are located in ways that minimize functional costs.For example. in the mature retail gasoline market. or on some other product differentiation basis). firms attempt to differentiate their products not by introducing radically new gasolines but rather by introducing slightly modified gasolines (cleaner-buming gasoline. and so forth) In declining industries Product differentiation can also be an important strategic option in a declining industry.

The rareness of a product differentiation strategy depends on the ability of individual firms to be creative. creative flair. Why differenciators should know about game theory ? A differenciated product strategy is also valuable if competitors are not likely to follow a similar approach. 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. Highly creative firms will be able to discover or create new ways to differentiate their products or services. management control systems. 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. Commonly required skills and resources : y y y y y strong marketing abilities product engineering creative flair corporate reputation for quality or technological leadership strong cooperation from channels . the organizational requirements for a product differentiation strategy emphasize innovativeness. These kinds of firms will always be one step ahead of the competition. this will lead to a win-win situation (game theoretic analysis needed). Organizing forsustained product differentiation advantage Organizational structure. Whereas the organizational requirements for a cost-leadership strategy focus on reducing costs in developing and manufacturing products. and related marketing abilities. If tthey do so.

scientists. or creative people Risks of differenciation y y y The cost of differenciation becomes too great Buyers become more sophisticated and need for differenciation falls Imitation narrows perceived differenciation .Common organizational requirements : y y y strong coordination among functions subjective measurement and incentives amenities to attract highly skilled labor.