In economics and marketing, product differentiation (or simply differentiation) is the process of distinguishing a product or service from others, to make it more attractive to a particular target market. This involves differentiating it from competitors' products as well as a firm's own products. The concept was proposed by Edward Chamberlin in his 1933 Theory of Monopolistic Competition.
Firms have different resource endowments that enable them to construct specific competitive advantages over competitors. Resource endowments allow firms to be different which reduces competition and makes it possible to reach new segments of the market. Thus, differentiation is the process of distinguishing the differences of a product or offering from others, to make it more attractive to a particular target market.
Although research in a niche market may result in changing a product in order to improve differentiation, the changes themselves are not differentiation. Marketing or product differentiation is the process of describing the differences between products or services, or the resulting list of differences. This is done in order to demonstrate the unique aspects of a firm's product and create a sense of value. Marketing textbooks are firm on the point that any differentiation must be valued by buyers (e.g.). The term unique selling proposition refers to advertising to communicate a product's differentiation.
In economics, successful product differentiation leads to monopolistic competition and is inconsistent with the conditions for perfect competition, which include the requirement that the products of competing firms should be perfect substitutes. There are three types of product differentiation:
- Simple: based on a variety of characteristics
- Horizontal: based on a single characteristic but consumers are not clear on quality
- Vertical: based on a single characteristic and consumers are clear on its quality
The brand differences are usually minor; they can be merely a difference in packaging or an advertising theme. The physical product need not change, but it could. Differentiation is due to buyers perceiving a difference; hence, causes of differentiation may be functional aspects of the product or service, how it is distributed and marketed, or who buys it. The major sources of product differentiation are as follows.
- Differences in quality which are usually accompanied by differences in price
- Differences in functional features or design
- Ignorance of buyers regarding the essential characteristics and qualities of goods they are purchasing
- Sales promotion activities of sellers and, in particular, advertising
- Differences in availability (e.g. timing and location).
The objective of differentiation is to develop a position that potential customers see as unique. The term is used frequently when dealing with freemium business models, in which businesses market a free and paid version of a given product. Given they target a same group of customers, it is imperative that free and paid versions be effectively differentiated.
Differentiation primarily affects performance through reducing directness of competition: As the product becomes more different, categorization becomes more difficult and hence draws fewer comparisons with its competition. A successful product differentiation strategy will move your product from competing based primarily on price to competing on non-price factors (such as product characteristics, distribution strategy, or promotional variables).
Most people would say that the implication of differentiation is the possibility of charging a price premium; however, this is a gross simplification. If customers value the firm's offer, they will be less sensitive to aspects of competing offers; price may not be one of these aspects. Differentiation makes customers in a given segment have a lower sensitivity to other features (non-price) of the product.
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- Sharp, Byron; Dawes, John (2001), "What is Differentiation and How Does it Work?," Journal of Marketing Management, 17, 739-59.