Sources of differentiation Advantage of the firm

A firm differentiates itself from its competitors when it provides something unique that is valuable to buyers beyond simply offering a low price. Differentiation allows the firm to command a premium price, to sell more of its product at a given price, or to gain equivalent benefits such as greater buyer loyalty during cyclical or seasonal downturns.1 Differentiation leads to superior performance if the price premium achieved exceeds any added costs of being unique. A firm’s differentiation may appeal to a broad group of buyers in an industry or only to a subset of buyers with particular needs. Brooks Brothers appeals to buyers wanting traditional clothing, for example, though many buyers view Brooks Brothers clothing as too conservative. Differentiation will be treated in general terms in this chapter, and Chapter 7 will describe how differences in buyer needs within an industry can lead to opportunities for differentiation through focus.

1. Differentiation and the Value Chain

Differentiation cannot be understood by viewing the firm in aggregate, but stems from the specific activities a firm performs and how they affect the buyer.2 Differentiation grows out of the firm’s value chain. Virtually any value activity is a potential source of uniqueness.

The procurement of raw materials and other inputs can affect the performance of the end product and hence differentiation. For example, Heineken pays particular attention to the quality and purity of the ingredients for its beer and uses a constant strain of yeast. Similarly, Steinway uses skilled technicians to choose the finest materials for its pianos, and Michelin is more selective than its competitors about the grades of rubber it uses in its tires.

Other successful differentiators create uniqueness through other primary and support activities. Technology development activities can lead to product designs that have unique product performance, as Cray Research has done in supercomputers. Operations activities can affect such forms of uniqueness as product appearance, conformance to specifications, and reliability. Perdue, for example, has bolstered its differentiation of fresh chickens by careful control of growing conditions and by feeding chickens marigolds to improve their color. The outbound logistical system can shape the speed and consistency of deliveries. For example, Federal Express has established an integrated logistical system using its Memphis hub that yields a level of delivery reliability unheard of prior to its entry into the small-parcel delivery business. Marketing and sales activities also frequently have an impact on differentiation. Timken’s sales force, for example, assists its buyers to use roller bearings more effectively in their manufacturing processes.

Figure 4-1 illustrates how any activity in the value chain can potentially contribute to differentiation. Even if the physical product is a commodity, other activities can often lead to substantial differentiation. Similarly, indirect activities such as maintenance or scheduling can contribute to differentiation just as do direct activities such as assembly or order processing. For example, a dust and fume free building can dramatically improve defect rates in semiconductor manufacturing.

Value activities representing only a small percentage of total cost can nevertheless have a major impact on differentiation. For example, inspection may represent only 1 percent of cost, but shipping even one defective package of drugs to a buyer can have major negative repercussions for a pharmaceutical firm’s perceived differentiation. Value chains developed for purposes of strategic cost analysis, therefore, may not isolate all activities that are important for differentiation. Differentiation analysis requires a finer division of some value activities, while others may be aggregated if they have little differentiation impact.

A firm may also differentiate itself through the breadth of its activities, or its competitive scope. Crown Cork and Seal offers crowns  (bottle caps) and filling machinery plus cans. It thus offers a full line of packaging services to its buyers, and its expertise in packaging machinery gives it more credibility and access in selling cans. Citicorp’s breadth of activities in financial services enhances its reputation as well as allowing its sales channels to offer a broader product range. A number of other differentiating factors can result from broad competitive scope:

  • ability to serve buyer needs anywhere
  • simplified maintenance for the buyer if spare parts and design philosophies are common for a wide line
  • single point at which the buyer can purchase
  • single point for customer service
  • superior compatibility among products

Figure 4 —1. R ep resen ta tive Sources of Differentiation in the Value Chain

Most of these benefits require consistency or coordination among activities if a firm is to achieve them.

Differentiation can also stem from downstream. A firm’s channels can be a potent source of uniqueness, and may enhance its reputation, service, customer training, and many other factors. In soft drinks, for example, independent bottlers are crucial to differentiation. Coca Cola and Pepsi Cola spend a great deal of attention and money attempting to upgrade bottlers and improve their effectiveness. Coke, for example, has been arranging the sale of less effective bottlers to new, more capable owners. Similarly, observers credit Caterpillar Tractor’s dealers with providing an important source of differentiation for Caterpillar. Cat’s approximately 250 dealers are by far the largest in the industry on average, and their size allows them to provide extensive service and buyer financing. Selective distribution through well- chosen outlets has also proven to be an extremely important source of differentiation for such firms as Estée Lauder and Hathaway.

Firms can enhance the role of channels in differentiation through actions such as the following:

  • channel selection to achieve consistency in facilities, capabilities, or image
  • establishing standards and policies for how channels must operate
  • provision of advertising and training materials for use by channels
  • providing funding so that channels can offer credit

Firms often confuse the concept of quality with that of differentiation. While differentiation encompasses quality, it is a much broader concept. Quality is typically associated with the physical product. Differentiation strategies attempt to create value for the buyer throughout the value chain.

2. Drivers of Uniqueness

A firm’s uniqueness in a value activity is determined by a series of basic drivers, analogous to the cost drivers described in Chapter 3. Uniqueness drivers are the underlying reasons why an activity is unique. Without identifying them, a firm cannot fully develop means of creating new forms of differentiation or diagnose how sustainable its existing differentiation is.

The principal uniqueness drivers are the following, ordered approximately in terms of their prominence:

Policy Choices. Firms make policy choices about what activities to perform and how to perform them. Such policy choices are perhaps the single most prevalent uniqueness driver. Johns Manville chooses to provide extensive customer training in installing its roofing products, for example, while Grey Poupon chooses to advertise mustard at a substantially higher rate of spending than historical industry practice. Much uniqueness, therefore, is discretionary.

Some typical policy choices that lead to uniqueness include:

  • product features and performance offered
  • services provided (e.g., credit, delivery, or repair)
  • intensity of an activity adopted (e.g., rate of advertising spending)
  • content of an activity (e.g., the information provided in order processing)
  • technology employed in performing an activity (e.g., precision of machine tools, computerization of order processing)
  • quality of inputs procured for an activity
  • procedures governing the actions of personnel in an activity (e.g., service procedures, nature of sales calls, frequency of inspection or sampling)
  • skill and experience level of personnel employed in an activity, and training provided
  • information employed to control an activity (e.g., number of temperature, pressure, and variables used to control a chemical reaction)

Linkages. Uniqueness often stems from linkages within the value chain or with suppliers and channels that a firm exploits. Linkages can lead to uniqueness if the way one activity is performed affects the performance of the other:

LINKAGES WITHIN THE VALUE CHAIN. Meeting buyer needs often involves coordinating linked activities. For example, delivery time is frequently determined not only by outbound logistics but also by the speed of order processing and the frequency of sales calls to take orders. Similarly, coordination between the sales force and the service organization can lead to more responsive customer service. Uniquely meeting buyer needs may also require the optimization of linked activities. In a number of industries such as copiers and semiconductors, for example, Japanese competitors have achieved dramatic reductions in defect rates by modifying every activity that influences defects instead of relying on a single value activity such as inspection. Similarly, higher investment in indirect activities such as maintenance can improve the performance of direct activities such as finishing or printing.

SUPPLIER LINKAGES. Uniqueness in meeting buyer needs may also be the result of coordination with suppliers. Close coordination with suppliers can shorten new model development time, for example, if suppliers tool up for producing new parts at the same time as a firm is completing the design of equipment to manufacture the new model. Similarly, missionary sales efforts by suppliers to a firm’s buyers can sometimes help differentiate a firm’s product.

CHANNEL LINKAGES. Linkages with channels can also lead to uniqueness in a variety of ways. By coordinating with channels or jointly optimizing the division of activities between the firm and the channels, uniqueness can frequently result. Some examples of how linkages with channels can lead to uniqueness are as follows: 33

  • training channels in selling and other business practices
  • joint selling efforts with channels
  • subsidizing for channel investments in personnel, facilities, and performance of additional activities.

Timing. Uniqueness may result from when a firm began performing an activity. Being the first to adopt a product image, for example, may preempt others from doing so and make the firm unique. This is one of Gerber’s sources of differentiation in baby food. Early regulatory approval for its soft contact lens gave Bausch and Lomb its differentiation. In other industries, moving late may allow a firm to employ the most modern technology and thereby differentiate. Chapter 5 discusses first-mover and late-mover advantages in more detail.

Location. Uniqueness may stem from location. For example, a retail bank may have the most convenient branch and automatic teller machine locations.

Interrelationships. The uniqueness of a value activity may stem from sharing it with sister business units. Sharing a sales force for both insurance and other financial products, as some leading firms are beginning to do, may allow the salesperson to offer the buyer better service. The analysis of interrelationships is described in Chapter 9.

Learning and spillovers. The uniqueness of an activity can be the result of learning about how to perform it better. Achieving consistent quality in a manufacturing process may be learning-driven, for example. As with cost, the spillover of learning to competitors erodes its contribution to differentiation. Only proprietary learning leads to sustainable differentiation.

Integration. A firm’s level of integration may make it unique. Integration into new value activities can make a firm unique because the firm is better able to control the performance of the activities or coordinate them with other activities. Integration may also provide more activities to be sources of differentiation. Providing service inhouse instead of leaving it to third party suppliers, for example, may allow a firm to be the only firm to also offer service or to provide service in a unique way compared to competitors. Integration may encompass not only supplier or channel activities, but it may involve performing activities currently performed by the buyer. By connecting hospitals to its computer system and allowing on-line ordering, for example, American Hospital Supply eliminates the need for some buyer activities and differentiates itself. Integration also sometimes makes the achievement of linkages with suppliers and channels easier. Reducing integration relative to competitors may be a source of differentiation in some industries. De-integration may exploit the capabilities of suppliers or independent channels, for example.

Scale. Large scale can allow an activity to be performed in a unique way that is not possible at smaller volume. For example, Hertz’s scale in car rental underlies some of its differentiation. Hertz’s many locations in all areas of the United States provide more convenient pick-up and drop-off of cars, and faster field service. The relevant type of scale that leads to differentiation will vary— with Hertz it is number of rental and service locations, while in another industry it might be the scale of plant that allows precise tolerances due to high speed equipment. In some cases, however, scale can work against the uniqueness of an activity. Scale may, for example, reduce the flexibility of fashion-related firms to buyer needs.

Institutional factors. Institutional factors sometimes play a role in allowing a firm to be unique. Similarly, a good relationship with its union may allow a firm to establish unique job definitions for employees.

The drivers of uniqueness vary for each activity and may vary across industries for the same activity. The drivers interact to determine the extent to which an activity is unique. A firm must examine each of its areas of uniqueness to see what driver or drivers underlie it. This will be critical to the sustainability of differentiation because some uniqueness drivers provide more sustainability than others. Policy choices may be easier for competitors to imitate than uniqueness stemming from interrelationships or exploiting linkages, for example. Understanding what allows it to be unique will also ensure that a firm does not undermine the causes. Finally, the drivers of uniqueness may suggest new sources of differentiation.

Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.

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