Differentiation is usually costly. A firm must often incur costs to be unique because uniqueness requires that it perform value activities better than competitors. Providing superior applications engineering support usually requires additional engineers, for example, while a highly skilled sales force typically costs more than a less skilled one. Achieving greater product durability than competitors may well re-quire more material content or more expensive materials—Rockwell’s water meters are more durable than competitors’ because they employ more bronze.
Some forms of differentiation are clearly more costly than others. Differentiation that results from superior coordination of linked value activities may not add much cost, for example, nor may better product performance that results from closer parts tolerances achieved through an automated machining center. In diesel locomotives, the higher tolerances achieved through automation improve fuel efficiency at low additional cost. Similarly, differentiating through having more product features is likely to be more costly than differentiating through having different but more desired features.
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:
- what makes an activity unique (uniqueness drivers) can impact cost drivers
- the cost drivers can affect the cost of being unique
In pursuing differentiation, a firm often affects the cost drivers of an activity adversely and deliberately adds cost. Moving an activity close to the buyer, for example, may raise cost because of the effect of the location cost driver. Smith International achieved differentiation in drill bits by maintaining large and more accessible inventories in the field, raising its cost.
At the same time as uniqueness often raises cost by affecting the cost drivers, the cost drivers determine how costly differentiation will be. A firm’s position vis-à-vis cost drivers will determine how costly a particular differentiation strategy will be relative to competitors. The cost of providing the most sales force coverage, for example, will be affected by whether there are economies of scale in the operation of the sales force. If economies of scale exist they may reduce the cost of increased coverage and make such coverage less costly for a firm with a large local market share.
Scale, interrelationships, learning, and timing are particularly important cost drivers in affecting the cost of differentiation. Though scale can itself lead to differentiation, it most often affects the cost of differentiation. Scale can determine the cost of a firm’s policy choice to advertise heavily, for example, or the cost of rapid introduction of new models. Sharing also can reduce the cost of differentiation.
IBM’S highly trained, experienced sales force is made less expensive by sharing it among a variety of related office products, for example. A firm moving faster down the learning curve in a differentiating activity will gain a cost advantage in differentiating, while moving early may lower the cost of differentiating in areas such as advertising where there is an accumulating stock of goodwill or other intangible assets.
The cost drivers thus play an important role in determining the success of differentiation strategies and have important competitive implications. If competitors have different relative positions vis-à-vis important cost drivers, their cost of achieving uniqueness in the affected activity will differ. Similarly, different forms of differentiation are relatively more or less costly for a firm depending on its situation vis-à- vis the cost drivers of the affected activities. Manufacturing parts with higher precision through automation can be less costly for a firm that can share the computerized machining center via interrelation- ships than for a firm that cannot. Similarly, Black & Decker has a faster rate of new product introduction than competitors in power tools but this rate is proportionally less costly for Black & Decker because of its leading worldwide market share. In the extreme, a firm may have such a large cost advantage in differentiating a particular value activity that its cost in that activity is actually lower than a firm not attempting to be unique in the activity. This is one reason why a firm can sometimes be both low cost and differentiated simultaneously, as was discussed in Chapter 1.
Sometimes making an activity unique also simultaneously lowers cost. For example, integration may make an activity unique but also lower cost if integration is a cost driver. Where achieving differentiation and reducing cost can take place simultaneously, however, this suggests that (1) a firm has not been fully exploiting all the opportunities to lower cost; (2) being unique in an activity was formerly judged undesirable; or (3) a significant innovation has occurred which competitors have not adopted, such as a new automated process that both lowers cost and improves quality.
Firms often fail to exploit opportunities to lower cost through coordination of linked activities that also raises differentiation. Better coordination of quotations, procurement, and manufacturing scheduling may lower inventory cost at the same time as it shortens delivery lead time, for example. More extensive inspection by suppliers may lower a firm’s inspection costs at the same time that the reliability of the end product is increased. Unexploited opportunities to reduce cost through linkages that also affect quality, in fact, are the reason underpinning the popular assertion that “quality is free.” The possibility of simultaneously raising differentiation and reducing cost through linkages exists, however, because the firm has not been fully exploiting cost reduction opportunities and not because differentiation is not costly.
If a firm has been aggressively reducing its cost, therefore, attempts to achieve uniqueness usually raise cost. Similarly, once competitors imitate a major innovation a firm can remain differentiated only by adding cost. In assessing the cost of differentiation, then, a firm must compare the cost of being unique in an activity with the cost of being equal to competitors.
Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.