Differentiation strategy of the firm

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   re­ quires 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. O ther 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 activi­ ties 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 crite­ ria. 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 sophisti­ cated 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 inno­ vated 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


Differentiation will lead to superior performance if the value per­ ceived 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-a-vis cost drivers, which can influence the firm’s approach to differentiation and its result­ ing performance. Stouffer’s high share has lowered its cost of advertis­ ing, 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.

1. 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 unique­ ness. 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 differenti­ ation so that it translates into superior performance. A number of approaches characterize successful differentiators:


Proliferate the sources o f 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 avail­ ability, and its dealer network;  and   Heineken  Beer, which combines raw material quality, consistency of taste, rapid shipping time to pre­ serve 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 o f value to reinforce differentiation on use criteria. A firm cannot gain the fruits of differentiation without adequate atten­ tion to signaling criteria. The  activities chosen to influence signaling criteria must be consistent with a firm’s intended  bases for differentia­ tion on use criteria. Pall Corporation, for example, showcases its exten­sive 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 im portant tools in differentiation, and bundling  informa­ tion with a product can often enhance differentiation. Effective descrip­ tions 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 minimiz­ ing inventory requirements. Finally, bundling information with a prod­ uct 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.


Exploit all sources o f 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 o f differentiation by controlling cost drivers, par­ ticularly the cost o f signaling. A firm can minimize the cost of differenti­ ation 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 im portant 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 expendi­ tures.

Emphasize form s o f 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 differen­ tiation strategy.


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 exam­ ple, may be perceived as more unique and more valuable by an engineer than by a purchasing agent. Shifting the decision maker  typically re­ quires modifying a firm’s value   chain  in   ways   such   as the   follow­ ing:

  • 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 re­ quires a different decision maker.

Discover unrecognized purchase criteria. Finding im portant  pur­ chase 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 differen­ tiation 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 an­ other important opportunity for differentiation strategies. Change  cre­ ates new bases for differentiation and  can lead buyers to   take a new look at products that have been routinely  purchased  from an estab­ lished 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 minicompu­ ters 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. Differentia­ tion that  lowers the buyers cost will often fare best during  difficult times for the buyer industry or as buyers get more sophisticated. Simi­ larly, differentiation based on quantifiable   performance  improvements for the buyer may command a more lasting price premium  than that based on  intangible performance advantages.


The discovery of an entirely new value chain  can unlock  possibili­ ties for differentiation. For  example, Federal   Express   differentiated itself by reconfiguring the traditional value chain  for small-parcel deliv­ ery completely. It bought  its own trucks  and   aircraft  and   pioneered the hub concept. It thereby improved  timeliness and reliability com­ pared to competitors using scheduled  airlines an d /o r 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

2. The  Sustainability   of  Differentiation

The sustainability of differentiation depends on two things, its continued perceived value to buyers and the lack of imitation by com­ petitors. 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-a-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  sus­ tainable under the following conditions:

Thefirm ’s sources o f uniqueness involve barriers. Proprietary learn­ ing, 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 barri­ ers. 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 o f 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.13 If differentiation at the same time creates switching costs, the sustainability of differentiation is in­ creased. 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 prod­ uct 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 neces­ sary 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.

3. Pitfalls   in   Differentiation

This chapter has suggested some common pitfalls that afflict firms pursuing differentiation strategies. M ost result from an incomplete understanding of the underlying bases of differentiation or its cost.


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.


If a firm does not understand the mechanisms by which its activi­ ties affect buyer value or the perception of value, it may be too differen­ tiated. 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 diminish­ ing 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.


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 tem pt 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.


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 buy­ er’s purchasing process.


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.


Some firms see differentiation only in terms  of the physical prod­ uct, 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.


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.

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