Product Differentiation in Economics

In marketing terms, 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. It is the marketing of generally similar products with minor variations that are used by consumers when making a choice. The concept was proposed by Edward Chamberlin in his 1933 The Theory of Monopolistic Competition.

If the company implements it successfully, product differentiation can give a good competitive advantage. Competitive advantage means having an edge over rivals in the provision of a certain product or service. This has made it very important for businesses to make their customers understand what difference they have to offer. When differentiating a product from others, it does not necessarily have to be completely different or new. If successful, product differentiation can create a competitive advantage for the product’s seller and ultimately build brand awareness.

There are two types of product differentiation –

  • Vertical Product Differentiation

Vertical differentiation exists when consumers compare a product according to one feature – quality. Explanation – If both A and B products are charged the same price to the consumer, then the market share for each one will be positive, according to the Hotelling model. The major theory in this all consumers prefer the higher quality product if two distinct products are offered at the same price. A product can differ in many vertical attributes such as its operating speed. What really matters is the relationship between consumers’ willingness to pay for improvements in quality and the increase in cost per unit that comes with such improvements. Therefore, the perceived difference in quality is different with different consumer, so it is objective.

  • Horizontal Product Differentiation

With horizontal differentiation, the product is harder to classify because it has many features. When products can’t be ordered in an objective way and are different in one or all of its features, then there is horizontal differentiation. For example, different color versions of the same iPhone or MacBook. A lemon ice-cream is not superior to a chocolate ice-cream, is completely based on the user’s preference. Consumers are not certain about the quality of the products that they compare.

Advantages of Product Differentiation

Besides being an imperative for survival in the competitive market, product differentiation has the following advantages:

  • Creates Value: Product differentiation gives a reason for the customers to choose the brand over others.
  • Helps in defending high prices: It helps the companies to give a reason why they charge a high price for their product.
  • Helps in non-price competition: It allows the companies to compete in areas other than price.
  • Creates brand loyalty: A successful differentiation strategy creates brand loyalty among the customers.

Disadvantages of Product Differentiation

  • Added pressure on the manufacturers: Product differentiation adds a substantial amount of pressure on the manufacturers to decide which attribute could turn out to be the USP for that product.
  • Can increase prices: Sometimes, differentiating a product adds to the production and marketing costs which can be transferred to the end-users.
  • Increased Revenue Not Guaranteed: Product differentiation doesn’t guarantee more sales and more revenue as a business can even fail in predicting whether the customer would appreciate the USP or not.