Differentiation Strategy

In contrast to the cost leadership strategy, implementation of a differentiation strategy

means that value is provided to customers through the unique features and characteristics
of a company's products rather than by the lowest price. Because differentiated products
satisfy customers' unique needs or preferences, companies can charge premium prices for
differentiated products.

For the company to be able to outperform its competitors and earn above-average returns,
the price charged for the differentiated product must exceed the cost of differentiation. In
other words, the price charged must exceed total product cost. Because of this, the
differentiated product's premium prices generally exceed the low price of the standard
product.

Companies that follow a differentiation strategy concentrate or focus on product

innovation and developing product features that customers value rather than on
maintaining the lowest competitive price (as is the case for the cost leadership strategy).

Figure: Drivers of Differentiation Strategy

Products can be differentiated in a number of ways so that they stand apart from
standardised products:

superior quality
unusual or unique features
more responsive customer service
rapid product innovation
advanced technological features
engineering design
additional features
an image of prestige or status

For example Intel uses speed, innovation, and manufacturing techniques as bases of
uniqueness.

Successfully implementing (and maintaining) a differentiation strategy means that a

company must consider its value chain of primary and secondary activities and
effectively link those activities as illustrated in Figure 6.6.

FIGURE: Value-Creating Activities Associated with the Differentiation Strategy

As noted in Figure above, the company's focus throughout its primary and secondary
value-creating activities is on establishing the importance of quality, accuracy, speed, and
responsiveness. The focus is also on understanding and meeting customers' unique
preferences and monitoring the speed, reliability, and quality of activities provided by
others that interface with the company's inbound and outbound logistics.

Differentiating Features That Raise the Performance a User Gets

To enhance the performance a buyer
Meet the buyers needs and
gets from using its product/service, a
requirements more completely,
company can incorporate features and
compared to competitors offerings.
attributes that
Give buyers the option to add on or to
Provide buyers greater reliability,
upgrade later as new product versions
durability, convenience, or ease of use. come on the market.
Make the companys product/service

Give buyers more flexibility to tailor

cleaner, safer, quieter, or more

maintenance-free than rival brands.

their own products to the needs of their

customers.

Exceed environmental or regulatory

standards.

Do a better job of meeting the buyers

future growth and expansion
requirements.

Source: Adapted from Michael E. Porter, Competitive Advantage, (New York: Free Press,
1985).

However, companies following differentiation strategies cannot completely ignore costs

and the need for minimal spending on process-related innovations. A company that
successfully implements a differentiation strategy can earn above-average returns even
when the five competitive forces are strong.

1. Rivalry with Existing Competitors Achieving customer loyalty means

differentiating products in ways that are meaningful to customers. Brand loyalty
means that customers will be less sensitive to price increases. As long as the
company satisfies the differentiated needs of loyal customers, it may be insulated
from price-based competition.

2. Bargaining Power of Buyers (Customers) Through meaningful differentiation,

companies develop products that are considered unique. This uniqueness may
insulate the company from competitive rivalry and reduce customer sensitivity to
price increases (similar to the insulation from rivalry with existing competitors).
By satisfying customer preferences in ways that no competitor can, companies
also are able to charge higher prices (because there are no comparable product
alternatives).

3. Bargaining Power of Suppliers Because the differentiator charges premium

prices, they are somewhat insulated from suppliers' price increases (as the
differentiator can absorb a greater level of cost increases from powerful suppliers
through its higher margins). Alternatively, because of lower price sensitivity by
customers, differentiators may be able to raise prices to cover increased supplierrelated costs. Because of the differentiator's focus on product quality and
responsiveness to customer preferences, suppliers also may be forced to provide
differentiators with higher quality materials, components, or services.

4. Potential Entrants The principal barrier to entry is customers' loyalty to the

uniquely differentiated brand. This means that a potential entrant must either
overcome (or surpass) the uniqueness of existing products or provide similarly
differentiated products at a lower price to increase customer value.

5. Product Substitutes Brand loyalty may effectively insulate differentiated

products from substitutes. Without brand loyalty, customers may switch to
substitutes that offer similar features at a lower price or to products offering more
attractive features at the same price.

Like the cost leadership strategy, the differentiation strategy also carries risks.

Customers may decide that the cost of uniqueness is too high. In other words, the price
differential between the standardised and differentiated product is too high. Perhaps the
company provides a greater level of uniqueness than customers are willing to pay for.

The company's means of differentiation no longer provides value to customers. For

instance, what is the value of prestige or exclusivity? And, how long will they last as
customers become more sophisticated?

Customer learning may reduce the customer's perception of the value of the company's
differentiation. Through experience, customers may learn that the extra price paid for a
differentiated product no longer has the value that it once did.

This loss of value through customer learning or changes in customer perceptions can be
illustrated by the experiences of IBM. Initially, the IBM name on a personal computer
signalled value to customers; however, clones soon challenged IBMs pre-eminent
position in the PC market. As customers learned that the clone machines offered similar
features at lower prices, the value attached to the IBM brand name diminished and IBMs
sales continue to suffer.

A fourth risk is concerned with counterfeiting. Increasingly, counterfeit goods (products

that attempt to convey differentiated features to customers at significantly reduced prices)
are a concern for many companies using the differentiated strategy.

In the event of any of the above, differentiators are challenged to increase value to
customers. This may mean reducing prices, adding product features without raising
prices, or developing new efficiencies in its value chain of primary and secondary
activities.

Generic Business-Level Strategies

Business-level strategy is concerned with a company's position in an industry, relative to
competitors and to the five forces of competition described earlier. Companies are
challenged to select business-level strategies to position themselves favourably (in terms
of the five competitive forces) and to establish a competitive advantage over industry
rivals.

FIGURE: Four Generic Business Level Strategies

Companies can choose one of four strategies from the generic strategy matrix based on
the source of competitive advantage--uniqueness or cost--and breadth of competitive
scope--broad or narrow.

A company choosing to compete across a broad market determines that it should compete
in a number of customer segments. Competitive advantage is achieved either by offering
unique products--a differentiation strategy--or by establishing a low-cost position and
providing standardised products at the lowest competitive price--a cost leadership
strategy.

Companies that choose to compete in narrow customer segments select a focus strategy,
which may be either a focused differentiation strategy (few segments, unique products) or
a focused cost leadership strategy (narrow segment, standardised products at the lowest
competitive price).

Satisfying Customer Needs

One of the biggest challenges for companies is to identify ways in which they can bundle
their resources and capabilities to create value for customers. Because, given the choice,
customers are most interested in purchasing products that both satisfy their needs and
provide value.

When a company decides whom it will serve, it must simultaneously identify the targeted
customer groups needs that its goods or services can satisfy. Top-level managers play a
critical role in recognising and understanding these needs since their insights about
customers influences product, technology, and distribution decisions.

The identification of key customer groups, customer needs, and preferences (for product
characteristics, features or value) must be determined. This implies that customer
knowledge (best gained through direct contact) should be a high priority for top-level
managers as well as for sales and marketing personnel because knowledge of customer

needs and preferences affects or influences companies' choices of the appropriate

technology, distribution, and products.

Customer knowledge becomes even more important as companies attempt to perpetuate

or sustain a competitive advantage. By listening to customers, companies can learn to
correctly anticipate their future needs and create product innovations ahead of their
competitors (to gain a first-mover advantage) and before competitors can imitate the last
value-added innovation.

Segmentation of Markets
It is imperative that companies pay careful attention to differences in customer needs
among customer groups and not arbitrarily "lump" them together because:
The availability of sophisticated information processing technologies allows companies
to identify unique bundles of customer characteristics and needs.
Competitors are becoming adept at precisely identifying even small--but strategically
relevant--differences in customer needs.

Thus, companies are challenged to use the tools

available to them to segment customers into
competitively relevant groups, groups with unique
needs or preferences. However, product or industry
characteristics may make market segmentation
difficult if not irrelevant in commodity-like markets
such as polyester yarn, bulk chemicals or cement.
Unfortunately, failing to make distinctions (where
they are appropriate) may mean that the company
attempts to be "all things to all people" and fails to
focus on its key customer groups (and on satisfying
their needs). Identifying Customers Needs

To survive and achieve strategic competitiveness in the todays competitive landscape,

companies must:

identify who their customers are

determine customer needs or preferences
focus on satisfying the needs of some group of customers
determine how to compete--select a strategy--that enables them to satisfy customer needs

The first step is to identify & segment customers based on differences in needs or
preferences. This enables the company to have a better grasp on what might be important
to a set of customers.

For consumer markets:

For Industrial markets:

Demographic factors

End-use segments

Socioeconomic factors

Product segments

Geographic factors

Geographic segments

Psychological factors

Common buying factor segments

Consumption patterns

Customer size segments

Perceptual factors

TABLE: Basis for Customer Segmentation

Once customers have been segmented into homogenous groups, companies must
determine whether or not differences in needs or preferences among customer groups are
significant. If they are not, companies might decide to offer a standard product to all
customers (a standard product is one that appeals to or satisfies the needs of an average or
typical customer).

Companies may choose to ignore significant differences in customer needs and offer
standard products because they believe that the product cannot easily be customised or
differentiated, or that the company's competencies are best suited to manufacturing
standard products. Companies that offer standard, undifferentiated products typically
offer them at the lowest competitive price as they follow a cost leadership strategy.
However, companies that choose to ignore significant differences in customer needs may
find that they no longer are strategically competitive

Business Strategy

The Strategic Management Process

The companys core competencies should be focused on satisfying customer needs or
preferences through business-level strategies. These strategies detail actions taken to
provide value to customers and gain a competitive advantage by exploiting core
competencies in specific, individual product or service markets. In other words, businesslevel strategies are developed based on a company's core competencies and indicate how
a company chooses to compete in a particular market to gain a competitive advantage
over competitors.

Figure: Path to Business Level Strategy

A company's business-level strategies are not formulated and implemented in isolation.

The Internet is having a great impact on customers, so companies must shape their
business-level strategies to adapt to this new form of commerce.

A company will be able to achieve strategic competitiveness and earn above-average

returns when customers are the focus or foundation for its strategic actions. A customer
focus requires that companies simultaneously evaluate or consider:
who to serve
what customer needs will be satisfied
how those needs will be satisfied through the strategy selected