The cost of differentiation infirm

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 re­quire 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 toler­ ances achieved through automation improve fuel efficiency at low addi­ tional 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-a-vis cost drivers will determine  how costly a particular  differentiation strategy  will be relative to competi­ tors. 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 im­ portant  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.

The cost drivers thus  play an im portant role in determining the success of differentiation strategies and have im portant competitive implications. If competitors have different relative positions vis-a-vis important cost drivers, their cost of achieving uniqueness in the affected activity will differ. Similarly, different forms of differentiation are rela­ tively more or less costly for a firm depending  on its situation   vis-a- vis the cost drivers of the affected activities. M anufacturing 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 m arket 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 simulta­ neously, 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 fu lly  exploiting all the opportunities to lower cost; (2) being unique in an activity was formerly judged undesir­ able; or (3) a significant innovation  has occurred  which competitors have not adopted, such as a new autom ated 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 schedul­ ing 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 possibil­ ity 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 m ajor 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.

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