Differentiation stems from uniquely creating buyer value. It can result through meeting use or signaling criteria, though in its most sustainable form it comes from both. Sustainable differentiation requires that a firm perform a range of value activities uniquely that impact those purchase criteria. Meeting some purchase criteria requires that a firm perform just one value activity well—for example, clever advertising. Other purchase criteria are affected by many of a firm’s activities. Delivery time, for example, can be influenced by operations, outbound logistics, and order processing, among others.
Many value activities typically play a role in meeting some use or signaling criterion. Figure 4-6 illustrates how purchase criteria can be arrayed against value activities to help a firm identify the activities important to differentiation. The links between the firm’s value chain and the buyer’s value chain, highlighted earlier, underlie an analysis such as that shown in Figure 4-6.
A firm’s overall level of differentiation is the cumulative value it creates for buyers in meeting all purchase criteria. The sources of differentiation in the firm’s value chain are often multiple, as illustrated by Stouffer’s successful differentiation strategy in frozen entrees (Figure 4-7). Stouffer’s has differentiated itself in both use and signaling criteria. Heavy spending on menu development has led to Stouffer’s having the highest proportion of unique dishes, as well as superior sauce technology. Care in ingredient selection and preparation has resulted in dishes of attractive, consistent appearance. Meals are more sophisticated in their menus and ingredients. Stouffer’s attractive packaging serves as a signal of value, reinforcing its quality image. Stouffer’s also pioneered high rates of spending on advertising in a product category where low spending levels had been the norm. It also innovated by advertising its frozen entrees as gourmet meals for busy people rather than as quick, filling meals for the family. Finally, Stouffer’s spends a considerable amount on a direct sales force and food brokers in order to gain attractive retail shelf displays, rapid restocking, and the removal of damaged merchandise. These multiple sources of uniqueness in its value chain combine to yield Stouffer’s a significant price premium over its competitors. Differentiation has also led to a substantial market share.
Figure 4-6. Relationship of Value Activities to Buyer Purchase Criteria
Figure 4-7. Sources of Stouffer’s Differentiation in Frozen Entrees
Differentiation will lead to superior performance if the value perceived by the buyer exceeds the cost of differentiation. Stouffer’s price premium exceeds the extra costs it deliberately incurs in advertising, packaging, ingredients, brokers, and research, and estimates suggest that it has been significantly more profitable than its competitors. 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 cost of differentiation will vary by value activity, and the firm should choose those activities where the contribution to buyer value is greatest relative to the cost. This may imply pursuing low cost sources of uniqueness as well as high cost ones that have high buyer value. The cost of differentiating in various ways will depend on the firm’s position vis-à-vis cost drivers, which can influence the firm’s approach to differentiation and its resulting performance. Stouffer’s high share has lowered its cost of advertising, product development, and procurement to the benefit of its performance.
The final component of differentiation strategy is sustainability. Differentiation will not lead to a premium price in the long run unless its sources remain valuable to the buyer and cannot be imitated by competitors. Thus a firm must find durable sources of uniqueness that are protected by barriers to imitation.
2. Routes to Differentiation
A firm can enhance its differentiation in two basic ways. It may become more unique in performing its existing value activities or it may reconfigure its value chain in some way that enhances its uniqueness. Becoming more unique in its value activities requires that a firm manipulate the drivers of uniqueness described earlier. In both cases, a differentiator must simultaneously control the cost of differentiation so that it translates into superior performance. A number of approaches characterize successful differentiators:
ENHANCE THE SOURCES OF UNIQUENESS
Proliferate the sources of differentiation in the value chain. A firm can often increase its overall differentiation by exploiting sources of uniqueness in additional value activities. Stouffer’s is a good example of how successful differentiation usually stems from cumulating uniqueness in many value activities. Other examples include Caterpillar Tractor, which combines uniqueness in product durability, parts availability, and its dealer network; and Heineken Beer, which combines raw material quality, consistency of taste, rapid shipping time to preserve freshness, heavy advertising, and wide distribution to differentiate in imported beer. Every value activity should be scrutinized for new ways to enhance buyer value. Some semiconductor manufacturers, for example, are offering computer-aided design facilities to their buyers who take over final design steps for their chips.
Make actual product use consistent with intended use. Since the way a buyer actually uses a product will determine its performance, differentiation can often suffer if a firm does not take steps to bring actual and intended use in line:
- Invest in understanding how the product is actually used by buyers
- Modify the product to make it easier to use correctly
- Design effective manuals and other instructions for use, rather than treating them as an afterthought
- Provide training and education to buyers to improve actual use, either directly or via channels.
Employ signals of value to reinforce differentiation on use criteria. A firm cannot gain the fruits of differentiation without adequate attention to signaling criteria. The activities chosen to influence signaling criteria must be consistent with a firm’s intended bases for differentiation on use criteria. Pall Corporation, for example, showcases its exten-sive R&D facilities in the liquid filtration industry through advertising and buyer visits to reinforce its differentiation in product performance. Since the buyer may fail to perceive indirect or hidden costs of a product, signaling may be as necessary to show the lack of value delivered by competitors as it is to show the value delivered by the firm. In addition, a differentiator must provide reassurance about the correctness of the buyer’s choice after sale. Signaling is only necessary to the extent that it helps buyers perceive the firm’s value, however, and no more.
Employ information bundled with the product to facilitate both use and signaling. Information and information systems are becoming increasingly important tools in differentiation, and bundling information with a product can often enhance differentiation. Effective descriptions of how a product works, how to use it, and how to service it can align intended use with actual use, as discussed above. Giving the product the capacity to generate information as it is used (e.g., a continuous readout of gasoline mileage in a car) can improve the product’s use as well as be valuable in its own right. Combining a product with information systems can raise buyer value in other ways as well. American Greetings, for example, provides retailers with an automated inventory management system to help them maintain their stock, thereby raising greeting card sales and at the same time minimizing inventory requirements. Finally, bundling information with a product about how the product was made, how unique it is, or how it performs relative to substitutes is often an effective way of signaling its value. Partagas fine cigars, for example, includes an insert with every box that explains the family history of the owners and how they have brought the Partagas brand from Cuba to the United States.
MAKE THE COST OF DIFFERENTIATION AN ADVANTAGE
Exploit all sources of differentiation that are not costly. Many activities can be made more unique at little extra cost. A good case in point is the use of linkages to improve differentiation. A firm may be able to differentiate itself simply by coordinating better internally or with suppliers or channels. Similarly, changing the mix of product features may be less costly than simply adding features. Other high priority targets for enhancing differentiation are activities in which cost is also reduced in the process. Reducing product defects may also reduce service cost, for example.
Minimize the cost of differentiation by controlling cost drivers, par- ticularly the cost of signaling. A firm can minimize the cost of differentiation by recognizing the impact of cost drivers. Firms should differentiate as efficiently as possible by paying careful attention to controlling the cost drivers of activities on which differentiation is based using the principles described in Chapter 3. General Motors, for example, is attempting to lower the cost of product variety through installing flexible manufacturing systems in a number of its auto plants. It is particularly important to find efficient ways of signaling because signaling does not itself create value. Signaling that draws on past investments or reputation (e.g., units in place, cumulative advertising) can be less costly than signaling that arises only from current expenditures.
Emphasize forms of differentiation where the firm has a sustainable cost advantage in differentiating. The cost of differentiating in various ways will differ among competitors. A firm should differentiate in those ways where it has a cost advantage. A large-share firm will have a cost advantage in differentiating in scale-sensitive activities such as advertising and R&D, for example, while a diversified firm may have an advantage in differentiating itself in ways where the cost of doing so is reduced by interrelationships with sister business units.
Reduce cost in activities that do not affect buyer value. In addition to seeking a cost advantage in differentiating, a firm must also pay attention to lowering cost in activities unrelated to the chosen differentiation strategy.
CHANGE THE RULES TO CREATE UNIQUENESS
Shift the decision maker to make a firm’s uniqueness more valuable. The identity of the decision maker in part defines what is valuable to the buyer, as well as the appropriate signals of that value. A firm may be able to increase its uniqueness or the perceived value of that uniqueness if it can alter the purchasing process in a way that elevates the role of decision makers who value more the firm’s particular forms of uniqueness. A product with highly sophisticated features, for example, may be perceived as more unique and more valuable by an engineer than by a purchasing agent. Shifting the decision maker typically requires modifying a firm’s value chain in ways such as the following:
- deploying a new type of salesperson
- involving technical people in the sale
- changing advertising media and content
- changing selling materials
- educating the buyer about new bases for the decision that requires a different decision
Discover unrecognized purchase criteria. Finding important purchase criteria that buyers (and competitors) have not recognized offers a major opportunity to achieve differentiation. It can allow a firm to preempt a new basis for differentiation and gain lasting benefits in image and reputation. Purchase criteria that are unrecognized are often use criteria, particularly those based on the indirect impacts a firm or its product has on the buyer’s value chain. Many great differentiation strategies were not passive responses to buyer demands, but were based on new approaches to differentiation. Stouffer’s discovered an entirely new way of differentiating frozen entrees, for example, just as Procter & Gamble was the first to advertise hand and body lotion year- round to consumers instead of seasonally. It discovered that hand and body lotion was used by buyers in ways unrecognized in previous strategies.
Preemptively respond to changing buyer or channel circumstances. Buyers or channels whose purchase criteria are changing provide another important opportunity for differentiation strategies. Change creates new bases for differentiation and can lead buyers to take a new look at products that have been routinely purchased from an established supplier. Increased health consciousness by buyers, for example, has led to the rapid penetration of caffeine-free soft drinks. Increased competition in a buyer’s industry can also enhance the buyer’s need for applications engineering assistance, or raise the value of lowering the buyer’s cost. In oil field equipment, for example, increasing financial pressure on buyers has favored suppliers who can demonstrate that they lower buyers’ cost. Similarly, buyer sophistication in minicomputers may be reducing the ability to differentiate on the basis of customer service but may be enhancing possibilities for differentiation based on delivery time, cost of use, and other more subtle bases. Differentiation that lowers the buyers cost will often fare best during difficult times for the buyer industry or as buyers get more sophisticated. Similarly, differentiation based on quantifiable performance improvements for the buyer may command a more lasting price premium than that based on intangible performance advantages.
RECONFIGURE THE VALUE CHAIN TO BE UNIQUE IN ENTIRELY NEW WAYS
The discovery of an entirely new value chain can unlock possibilities for differentiation. For example, Federal Express differentiated itself by reconfiguring the traditional value chain for small-parcel delivery completely. It bought its own trucks and aircraft and pioneered the hub concept. It thereby improved timeliness and reliability compared to competitors using scheduled airlines and/or long-distance trucks combined with many distribution points and sorting centers. Hanes’s L’eggs pantyhose, with its innovative packaging, distinctive in-store displays, and sales and delivery directly to supermarkets, serves as another example of how a new value chain can be the key to a successful differentiation strategy. Opportunities to achieve dramatic levels of differentiation often result from reconfiguring the value chain.
Conceiving of a new value chain is a creative process. Working backward from the buyer’s value chain, a firm should probe for ways it might link with the buyer’s chain differently or restructure its own value activities to meet purchase criteria better. Common reconfigurations involve areas such as the following:
- a new distribution channel or selling approach
- forward integration to take over buyer functions or eliminate the channels
- backward integration to control more determinants of product quality
- adoption of an entirely new process technology
3. The Sustainability of Differentiation
The sustainability of differentiation depends on two things, its continued perceived value to buyers and the lack of imitation by competitors. There is an ever-present risk that buyers’ needs or perceptions will change, eliminating the value of a particular form of differentiation. Competitors may also imitate the firm’s strategy or leapfrog the bases of differentiation a firm has chosen.
The sustainability of a firm’s differentiation vis-à-vis competitors depends on its sources. To be sustainable, differentiation must be based on sources where there are mobility barriers to competitors replicating them. As discussed earlier, the drivers of uniqueness differ in their sustainability while the cost of differentiation may also vary among competitors and affect sustainability. Differentiation will be more sustainable under the following conditions:
The firm’s sources of uniqueness involve barriers. Proprietary learning, linkages, interrelationships, and first-mover advantages tend to be more sustainable drivers of uniqueness than simply a policy choice to be unique in an activity as was discussed earlier. Signaling activities such as advertising can also be sustainable because they involve barriers. However, differentiation based too heavily on signaling tends to be vulnerable to increasing buyer sophistication.
The firm has a cost advantage in differentiating. A firm with a sustainable cost advantage in performing the activities that lead to differentiation will enjoy much greater sustainability.
The sources of differentiation are multiple. The overall difficulty of imitating a differentiation strategy depends in part on how many sources of uniqueness a firm has. The sustainability of a differentiation strategy is usually greatest if differentiation stems from multiple sources, rather than resting on a single factor such as product design. A single basis for differentiation provides a strong focal point for competitors. Differentiation that results from coordinated actions in many value activities will usually be more durable, since it requires wholesale changes in competitor behavior to imitate.
A firm creates switching costs at the same time it differentiates. Switching costs are fixed costs incurred by the buyer when it changes suppliers, which allow a firm to sustain a price premium even if its product is equal to that of competitors.41 If differentiation at the same time creates switching costs, the sustainability of differentiation is increased. Switching costs, like differentiation itself, grow out of the way in which a product is used by the buyer. Activities that make a firm unique can frequently raise the cost of switching since the buyer often tailors its activities to exploit the firm’s uniqueness.
The Stouffer’s example described earlier provides an illustration of how the sustainability of a firm’s sources of differentiation can be assessed (see Figure 4-7). Of Stouffer’s sources of differentiation, the most sustainable are probably its menu and sauce technology, its product positioning and brand image, its relationships with prime food brokers, and its cost advantage in advertising because of its leading market share. Heavy investment by competitors would likely be necessary to replicate these factors if they could be replicated at all. As a result, StoufFer’s differentiation has been sustainable over a long period of time. Conversely, Hanes’s new packaging of pantyhose and direct distribution to grocery stores were policy choices not protected by proprietary learning, substantial scale advantages in executing them, or other barriers to imitation. Hanes’s differentiation has thus been extensively imitated by competitors and has not yielded a significant price premium.
4. Pitfalls in Differentiation
This chapter has suggested some common pitfalls that afflict firms pursuing differentiation strategies. Most result from an incomplete understanding of the underlying bases of differentiation or its cost.
UNIQUENESS THAT Is NOT VALUABLE
The fact that a firm is unique at something does not necessarily mean it is differentiated. Uniqueness does not lead to differentiation unless it lowers buyer cost or raises buyer performance as perceived by the buyer. The most persuasive differentiation often stems from sources of value the buyer can perceive and measure, or from difficult- to-measure sources of value that are extensively signaled. A good test of the value of uniqueness is whether a firm can command and sustain a price premium in selling to well-informed buyers.
TOO MUCH DIFFERENTIATION
If a firm does not understand the mechanisms by which its activities affect buyer value or the perception of value, it may be too differentiated. If product quality or service levels are higher than buyers’ need, for example, a firm may be vulnerable to competitors with the correct level of quality and a lower price. Unnecessary differentiation is the result of failure to diagnose performance thresholds or diminishing returns in buyer purchase criteria. This, in turn, stems from a lack of understanding of how a firm’s activities relate to the buyer’s value chain.
TOO BIG A PRICE PREMIUM
The price premium from differentiation is a function of value of differentiation and its sustainability. A differentiated competitor will be abandoned by buyers if the premium gets too high. Unless a firm shares some of the value created with the buyer in the form of a more reasonable price, moreover, it may tempt the buyer to backward integrate. The appropriate price premium is a function not only of a firm’s extent of differentiation, but also of its overall relative cost position. If a firm does not keep its costs in proximity to competitors’, the price premium may grow beyond sustainable levels even if a firm’s differentiation is maintained.
IGNORING THE NEED TO SIGNAL VALUE
Firms sometimes ignore the need to signal value, basing their differentiation strategies on use criteria that are seen as the “real” bases for differentiation. However, signals of value exist because buyers are not willing or able to fully discern differences among suppliers. Ignoring signaling criteria can open a firm to attack from a competitor providing inferior value but having a better understanding of the buyer’s purchasing process.
NOT KNOWING THE COST OF DIFFERENTIATION
Differentiation does not lead to superior performance unless its perceived value to the buyer exceeds its cost. Firms often do not isolate the cost of the activities they perform to differentiate themselves, but instead assume that differentiation makes economic sense. Thus they either spend more on differentiation than they recover in the price premium, or fail to exploit ways of reducing the cost of differentiation through understanding its cost drivers.
FOCUS ON THE PRODUCT INSTEAD OF THE WHOLE VALUE CHAIN
Some firms see differentiation only in terms of the physical product, and fail to exploit opportunities to differentiate in other parts of the value chain. As has been discussed, the entire value chain often provides numerous and sustainable bases for differentiation, even if the product is a commodity.
FAILURE TO RECOGNIZE BUYER SEGMENTS
Buyer purchase criteria and their ranking usually vary among buyers, creating buyer segments. If a firm does not recognize the exis-tence of these segments, its strategy may not meet the needs of any buyer very well, making it vulnerable to focus strategies. The existence of buyer segments does not mean that a firm must choose a focus strategy, but rather that it must base its differentiation on widely valued purchase criteria. The strategic issues raised by industry segmentation will be discussed more extensively in Chapter 7.
Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.