Product Differentiation

Have you ever gone shopping and lost yourself in tons of options? The available options for one type of product are increasing every single day. Let's say you want to buy some shampoo. What makes one shampoo different from another one from a different brand and how would you decide? The smell, the ingredients, the cost? What if they both have the same smell, how do you decide which one to choose? The cheap one or the one that you saw on the TV commercial the other day. One way or another, the firms differentiate the products in a way that the customers prefer one of them to another.

Product differentiation is a widely used marketing strategy that gives firms a competitive advantage in a competitive market. How exactly does the product differentiation work and what are the advantages? Let’s continue reading and find out together!

Fig. 1 - Supermarket

Product differentiation in monopolistic competition

Product differentiation plays an important role for firms that are in monopolistic competition. With the help of product differentiation, firms in monopolistic competition can have some market power over the price of their products.

Firms in monopolistic competition try to stand out to target customers and distinguish themselves from other competitive firms. The aim is to use the competitive advantage, build brand awareness and ultimately sell a higher number of products and increase growth.

Product differentiation definition

Firms in a competitive market struggle to have influence over demand and price and are most often considered price takers, meaning they take whatever price the market settles at. If firms accepted this they would not have an incentive to invest in their product because they will still be subject to the market price. So firms try to separate their product from the competition, through higher quality, additional features, or preference matching. When firms make consumers believe their product has additional benefits than others, they then gain market power to raise their price without losing buyers.

Product differentiation strategy

How do the firms differentiate the products in the same industry? The answer is actually not surprising: by producing different products. Product differentiation is a marketing strategy that aims to attract more customers and encourage them to choose a certain brand instead of other alternatives. To do so, a firm should identify the preferences of the customers, and the qualifications of the product, and emphasize how the product satisfies those preferences.

There are different types of differentiation such as differentiation by style or type, location, and quality. We will discuss each one in detail in the following.

Differentiation by type

The type of product can be analyzed in different categories. Similarly, firms from a certain industry can produce products in different categories, too. Let’s take the food industry as an example. We can differentiate the food industry into various categories such as Tv dinner food, Asian food, take-out food, and organic food are just a few examples.

Let’s assume that you are at the food court in a shopping mall and you want to eat something from one of the restaurants. There are a lot of different types of foods available, right? At the first look, you can have hamburgers, pizza, sushi, steak, or salads for instance. You can differentiate one of the categories even more. Let’s take hamburgers. There can be fast-food hamburgers, gourmet burgers, and vegan burgers. All of these categories are examples of differentiated products.

The consumed type of product depends on the preferences of the customers. These preferences can not only change from one customer to another but also from time to time. A young woman who has limited time to hang out with friends would go to a fast-food restaurant whereas she would prefer a more classy restaurant if she has a business lunch with one of her potential clients. It may also depend on further personal details and preferences such as what the person ate in the morning, and whether he or she has some health issues or allergies.

It would also be the case that the customers do not have any constraints or previous preferences and will eat from the most attractive restaurant. Alright, what does the attractive restaurant mean then? Maybe the one that is the most crowded, less crowded, the one that has the best smell, or the biggest brand signboard? These also depend on personal preferences and firms often try to differentiate their product types in order to target specific customer groups with certain preferences.

Fig. 2 - Food Court

Location

Location is another type of product differentiation strategy. If there are two bakeries around your neighborhood and if you want to buy some coffee and bagels on your way to your job, it is more likely that you would prefer the shop from the bakery that is on your way, rather than the other one on the opposite direction.

Since the customers generally find the shops around them more convenient, firms use the location as an important element in the product differentiation strategy. Have you ever recognized that lots of restaurants locate around a work complex, stationery shops around a school, or pharmacies around a hospital? Even though the prices at the nearest shop are not cheap, some customers would still prefer to shop from the seller who is closest to them.

Quality

Quality is one of the main types of product differentiation strategy. The firms often position themself according to some niche groups or the quality/price level. Let’s think about cars? Considering a car’s goal is to make you move from one location to another one, all cars should be the same, right? As you know the reality is too far from that: sports cars, family, cars, sedans, autonomous cars, jeeps, and more. All these types of cars can be differentiated even more by added features: cars with folding tops, autonomous cars, cars with better sound systems, and many more.

Since the willingness to pay for a higher quality changes from customer to customer, producers often vary the quality of their products as well. Some firms may offer low-quality products with basic features at inexpensive prices and others may offer more luxurious and high quality at higher prices.

Types of product differentiation

Figure 1. Product Differentiation Types, StudySmarter Original

There are a couple of product differentiation types that affect how customers make their buying decisions. Three of the types are vertical differentiation, horizontal differentiation, and mixed differentiation.

Vertical differentiation

Vertical differentiation is when customers make a buying decision based on objective measurement, for instance, price or quality.

Although the decision is based on objective measurement, the way the customers choose to make a decision may change from customer to customer. For instance, a customer might prefer to buy high-quality products whereas another customer may prefer always the product with the cheapest price. For example, some consumers prefer to be the newest cell phone decked out with features for over a thousand dollars, whereas others prefer the cheapest flip phone that can make calls. As we see in these vertical differentiation examples, customers can make a buying decision based on objective measurement even though the preference might be person-specific.

Horizontal differentiation

Horizontal differentiation is when customers make a buying decision based on individual preferences subjectively. This is because sometimes it is not possible to rank different products quantitatively.

For instance, some customers prefer bitter chocolate and some prefer white chocolate. At a restaurant, a customer may prefer always the chef’s suggestion and another one would like to have the option with fewer calories. There is no qualitative measurement to rank these two different types of chocolates. In this case, the decision is made completely based on a personal taste.

Mixed differentiation

There are also some cases where we observe horizontal and vertical differentiation together. We see mixed differentiation when the purchased products are complex.

Let’s assume that you want to buy an apartment. Customers should consider the objective characteristics such as how large is the apartment, how many rooms are there, and the price. However, customers would like to take into account other personal aspects as well. For instance, some customers might like quiet places whereas others want to be in the city center. For some customers, it might be important to have a new apartment but for others, the price might come first. Therefore, each consumer would put a different weight of importance on all different objective and subjective aspects. Since the preferences vary a lot, the offered products need to be differentiated as well.

Advantages of product differentiation

What are the advantages of product differentiation for customers and firms? As we discussed above, having wider options due to the differentiated products should benefit the customers. After all, having multiple options and the opportunity to pick the best one according to you is always better than having limited options.

Why are firms producing differentiated products? Just to offer more options to their beloved customers? Not so likely, right? Product differentiation has lots of monetary benefits for the firms by increasing their chance to capture a larger share in the market as well as stand out from their competing firms.

Brand loyalty

By differentiating the products, a firm can create a brand perception where customers might connect the brand name with characteristics or even values. By doing so, firms can create and increase their brand loyalty. If customers perceive a product better in particular ways compared to alternatives, customers are usually more likely to have a higher willingness to pay.

Price points

It can be hard to differentiate certain products, like bottled water, firms can try to lower the costs and stand out as the firms that offer the same quality for a better price. By doing so, the firm could increase the number of sales and make a higher profit eventually.

Narrowing down the target audience

The price and quality are not the only way that makes firms stand out from the competition. Firms can focus on some values or concerns of the target groups to differentiate their brands.

Product Differentiation Examples

Businesses can focus on customers who have particular passions, whether it's building a happy community, environmental justice, or healthy lifestyles. Brands will try to provide specific to these interests in an attempt to bring people's passions to include consuming products that agree with them.

If the product differentiation strategy works successfully for the firm, the consumer interest in the brand will increase and prefer this brand rather than another despite costs of quality differences. The increased brand loyalty should help the firm to have a larger market share and grow more. Therefore, product differentiation strategies play an important role for firms in competitive markets such as monopolistic competition.