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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 gets from using its product/service, a company can incorporate features and attributes that Provide buyers greater reliability, durability, convenience, or ease of use. Make the company's product/service cleaner, safer, quieter, or more maintenance-free than rival brands. Exceed environmental or regulatory standards.	Meet the buyer's needs and requirements more completely, compared to competitors' offerings. Give buyers the option to add on or to upgrade later as new product versions come on the market. Give buyers more flexibility to tailor their own products to the needs of their customers. Do a better job of meeting the buyer's 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 supplier-related 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 IBM's 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 IBM's 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.