The Cost Of Differentiation

Attempts to achieve differentiation usually raise costs. The cost of differentiation reflects the cost drivers of the value activities is based. The cost drivers play an important role in determining the success of differentiation strategies and have important competitive implications.

The cost of differentiation reflects the cost drivers of the value activities on which uniqueness is based. The relationship between uniqueness and cost drivers takes two related forms:

  1. what makes an activity unique (uniqueness drivers) can impact cost drivers
  2. the cost drivers can affect the cost of being unique.

Buyer Value And Differentiation

A successful differentiator finds ways of creating value for buyers that yield a price premium in excess of the extra cost. A firm creates value for a buyer through two mechanisms:

  1. by lowering buyer cost
  2. by raising buyer performance

For industrial, commercial, and institutional buyers, differentiation requires that a firm be uniquely able to create competitive advantage for its buyer in ways besides selling to them at a lower price. For households and individual consumers, the cost of a product includes not only financial costs but also time or convenience costs.

A firm lowers buyer cost or raises buyer performance through the impact of its value chain on the buyer's value chain. The links between a firm and its buyer's value chain that are relevant to buyer value depend on how the firm's product is actually used by the buyer. Therefore, differentiation grows out of all the links between a firm and its buyer in which the firm is unique.

A firm can lower its buyer's cost in a number of ways. Table 9-2 lists some of the ways in which a firm's product itself can lower the buyer's direct cost of use.

Buyers seldom pay for value they don't perceive. Thus the price premium a differentiation strategy commands reflects the value actually delivered to the buyer and the value the buyer perceives (even if is not actually delivered). According to this, buyers purchase criteria can be divided into two types:

Use criteria
Use criteria might include such factors as product quality, product features, delivery time, and applications engineering support.
Signaling criteria
Signaling criteria might include factors such as advertising, the attractiveness of facilities, and reputation. Such signals of value may be as important as actual value (1) when the nature of differentiation is subjective or hard to quantify, (2) when buyers are making a first-time purchase, (3) when repurchase is infrequent, and (4) when buyers are unsophisticated.

Differentiation will lead to superior performance if the value perceived by the buyer exceeds the cost of differentiation. Differentiation strategy aims to create the largest gap between the buyer value created (and hence the resulting price premium) and the cost of uniqueness in a firm's value chain. The final component of differentiation strategy is sustainability.

A firm can enhance its differentiation in two basic ways:

  1. It may become more unique in performing its existing value activities.
  2. It may reconfigure its value chain in some way that enhances its uniqueness.

A number of approaches characterizes successful differentiators:

Enhance the sources of uniqueness:

  • Proliferate the sources of differentiation in the value chain
  • Make actual product use consistent with intended use
  • Employ signals of value to reinforce differentiation on use criteria
  • Employ information bundled with the product to facilitate both use and signaling.

Make the cost of differentiation an advantage

This chapter deals with the issue of how should a firm competes in its chosen industry or business(es).

Michael Porter is credited with clarifying the issue of how firms can achieve competitive advantage. He proposes a three-stage progression to achieving competitive advantage: analyse the industry structure, decide competitive strategy, and implement competitive strategy.

Examination of the structure of the industry will establish the industry's "market attractiveness" and the firm's competitive positions within it.

Porter's second stage involves the firm deciding on a competitive strategy. He identified three generic strategies: differentiation, cost leadership, and focus, for creating a defendable position in the long rung and outperforming competitors in an industry. Each strategy represents a different way for firms to gain a competitive advantage in their industry. Which generic strategy is chosen is a function of the firm's strengths and weaknesses combined with the competitors' positions in the market.

The final stage is implementation of the strategy to achieve sustainable competitive advantage. In his book Competitive Advantage, Porter describes the way a firm can choose and implement a generic strategy and sustain competitive advantage.

Why do some managements make the right choices is selecting product, industries, an activity configurations? In paper "Towards a Dynamic Theory of Strategy" Porter moves to a dynamic theory of strategy and gives his own current answer that one important category of the origins of competitive success is the local environment in which a firm is based.

This chapter also reviews the importance of technology in shaping competitive position in an industry.

The relationship between corporate-and business-level strategies is reviewed. The idea of strategic fit assumes that the two levels of strategy are consistent and that the firm competes at the business level in ways that it has expertise.

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