Differentiation Strategy is the strategy that lays emphasis on offering a superior product, on some dimension(s), compared to what competitors are providing. Differentiation is possible along one or more of various dimensions – product features, quality, customer service, guarantee, distribution, delivery, product customization, etc.
Michael Porter asserts that businesses can stand out from their competitors by developing a differentiation strategy. With a differentiation strategy the business develops product or service features which are different from competitors and appeal to customers including functionality, customer support and product quality.
“Differentiation provides insulation against competitive rivalry because of brand loyalty . . . The resulting customer loyalty and need for a competitor to overcome the uniqueness create entry barriers. Differentiation yields high margins with which to deal with supplier power and clearly mitigates buyer power since buyers lack comparable alternatives and are thereby less price sensitive. Finally, the firm that has differentiated itself to achieve customer loyalty should be better positioned vis-à-vis substitutes than its competitors” (Porter, 1985:14 and Porter, 1980:37).
A successful differentiation strategy emphasizes uniqueness in ways that are valued by buyers. If buyers are willing to pay for these unique features and the firm’s costs are under control, then the price premium will lead to higher profitability. The key success factor in differentiation is sound understanding of the buyer needs. A differentiator needs to know what buyers value, deliver that particular bundle of attributes and charge accordingly. By effectively serving a sub-group of buyers who will not consider other firms’ offerings as substitutes for this offering, the company can effectively lock up the segment.
A successful differentiation strategy reduces the head-to-head rivalry witnessed in price based competition. If suppliers raise prices, loyal customers who are not price conscious are more likely to accept the higher price that the differentiator passes on. Customer loyalty also acts as a barrier to new entrants and as a hurdle that potential substitute products have to overcome.
To become a differentiator a company must make choices about its product, market, and distinctive competencies.
- The differentiator aims for a very high level of differentiation and frequently produces a wide range of products. Differentiation can be achieved through quality, innovation, and responsiveness to customers.
- A differentiator segments its market into many niches, offering products for many market niches.
- For a differentiator, the importance of each function depends on the source of the differentiation. For example, if it seeks a competitive advantage based on innovation, the key function is R&D. This does not imply that manufacturing is unimportant. Instead, the differentiator wants to control costs enough so that the price charged is not higher than what customers are willing to pay.
The differentiation strategy provides businesses with some advantages, as discussed in terms of Porter’s Five Forces Model.
- Competitors are less of a threat for differentiators, due to the company’s brand loyalty.
- Powerful suppliers are rarely a problem because the differentiator’s strategy is not as focused on driving down costs as is a cost leader’s strategy. Increased costs can often be passed on to customers.
- Powerful buyers are rarely a problem because only the company can supply the differentiated product.
- The threat of substitute products is low, due to the low probability of finding another product that can meet the same customer needs and break brand loyalty.
- Potential entrants are discouraged by the high cost of developing a unique product to compete against the differentiator, who enjoys strong brand loyalty.
However, the differentiation strategy is not without its risks:
- If the basis for differentiation is easily imitated, it will not lead to a sustainable advantage. Then rivalry within the industry is likely to switch to price-based competition.
- Broad-based differentiators may be outmaneuvered by specialist companies who target one particular segment.
- If the strategy is based on continual product innovation, the company runs the risk of exploiting risky territory merely for followers to exploit the benefits.
- If the firm ignores the costs of differentiating, the premium prices charged may not lead to superior profits.