Product Differentiation

10 Key excerpts on "Product Differentiation"

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  eBook - ePub

  Industrial Organization

  Competition, Growth and Structural Change

  • Kenneth George, Caroline Joll, E L Lynk(Authors)
  • 2005(Publication Date)
  • Routledge

    (Publisher)

  Chapter 8

  Product Differentiation

  8.1 INTRODUCTION

  In this chapter we turn from oligopolistic pricing to an aspect of non-price competition which can be very important in oligopolistic markets. In contrast to the perfectly competitive model in which a large number of sellers all produce exactly the same product, in an oligopoly the firms typically produce differentiated or heterogeneous products and are thus able to compete by varying the characteristics of their products as well as, or indeed instead of, changing their prices.

  Product Differentiation refers to a situation in which two or more products are perceived by consumers to be close, but not perfect, substitutes. This is a very broad definition, and two types of Product Differentiation are usually distinguished and analysed separately. Horizontal differentiation (product range) occurs when a market contains a range of similarly priced products. An increase in the range of products means that consumers will, on average, be able to find a product which meets their preferences more exactly. With vertical (or quality) differentiation the products differ in respect of quality and there is agreement on the ranking of the products; buyers differ, however, in their willingness to pay for more quality. The scope for horizontal Product Differentiation, in particular, is greater in consumer than in producer goods industries and the definition of Product Differentiation shows the importance of consumers’ perceptions to this phenomenon. Product. differentiation can have a subjective dimension in that packaging or presentational variations can cause consumers to overestimate the difference between brands.

  In fact, the concept of Product Differentiation is a subtle one and a full understanding of what is meant by Product Differentiation shows how ubiquitous the practice is. ‘New’ theories of consumer behaviour have analysed consumption as a form of productive process in which the household combines commodities in order to produce a desired mix of characteristics (Lancaster 1966) or combines bought commodities with time inputs in order to produce a desired mix of activities (Becker 1965). Because differentiated products may be seen as combining the same characteristics in different proportions, Lancaster’s model has been widely used to analyse Product Differentiation, as we shall see in section 8.2 below. However, Becker’s model also suggests some less obvious forms of Product Differentiation, because the purchased good represents only one differentiation in the other inputs such as time or amount of service offered. Thus, for instance, corner shops usually charge higher prices than supermarkets for the same products, but the local shops can be reached more quickly and cheaply and are often open longer hours.

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  Product and Services Management

  • George Avlonitis, Paulina Papastathopoulou(Authors)
  • 2006(Publication Date)
  • SAGE Publications Ltd

    (Publisher)

  These concurrent revolutions in production, communication and transportation coupled with the fact that industries become oligopolistic (namely, the supply of products was concentrated in the hands of relatively few sellers) brought forward other non-pricing bases of competition. In the beginning of the twentieth century the more percipient economists had recognized that such changes had taken place and that Product Differentiation was more typically the basis of competition than was price. This view was crystallized by Robinson (1932) and Chamberlin (1933). Abandoning the assumptions of a homogeneous product, both authors developed the theory of ‘monopolistic competition’ under which the seller’s sales are limited and defined by two more variables in addition to price, namely the nature of the product and advertising outlays.

  In Chamberlin’s monopolistic competition theory the product is defined as a ‘bundle of utilities’ in which the physical offering is but one element, and becomes the basis on which a seller can differentiate his offering from that of his competitors. Chamberlin (1957) argues that buyers in the market have a real freedom to differentiate, distinguish, or have specific preferences among the competing outputs of the sellers. This view led to the development of the differential advantage concept, one of the most important concepts in the marketing theory.

  Alderson (1965) has attempted to provide the link between the concept of differential advantage and the economy as it actually exists. Alderson has noted that differentiation in a product’s characteristics gives a seller control over the product with that exact identity and configuration, supporting the view that ‘the seller offering a product different from others actually does occupy a monopoly position in that limited sense’. However, Product Differentiation can be based on product characteristics such as patented features, trademarks, packaging (for example, design, colour, style) (Alderson, 1965).

  It is, however, the existence of varied wants and needs in the market place that allows competition through Product Differentiation and a policy of differential advantage to be pursued. Alderson asserts that, behind the acceptance of differentiation are differences in taste desires, income, location of the buyers, and the uses of commodities. Smith (1956) also notes that the seller pursues a policy of differential advantage in general, and Product Differentiation in particular, in order to meet both competitive activities and the various needs and wants in the market place. However, the seller can pursue a policy of Product Differentiation, either by offering the same product throughout the whole market and secure a measure of control over the product’s demand by advertising and promoting differences between his/her product and the product’s of competing sellers, or by viewing the market as a number of small homogeneous markets (market segments) each having different product differences and adjusting the product and the elements surrounding its sale according to the requirements of each market segment. The seller who adopts the latter method in pursuing a policy of Product Differentiation, is actually pursuing a policy of market segmentation.

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  Pricing and Revenue Optimization

  • Robert Phillips(Author)
  • 2005(Publication Date)
  • Stanford Business Books

    (Publisher)

  4

  PRICE DIFFERENTIATION

       

  In this chapter we treat one of the most fundamental concepts in PRO—price differentiation . Price differentiation refers to the practice of a seller charging different prices to different customers, either for exactly the same good or for slightly different versions of the same good. Price differentiation is a powerful way for sellers to improve profitability. It also adds a new level of complexity to pricing, often creating a need to use analytical techniques to improve the calculation and updating of prices over time.

  We use the term price differentiation to refer to the ways that additional profit can be extracted from a marketplace by charging different prices. Tactics for price differentiation include charging different prices to different customers (or groups of customers) for exactly the same product, charging different prices for different versions of the same product, and combinations of the two. The term price discrimination is used in the economics literature to refer to much the same thing. We use the term price differentiation , rather than the more common price discrimination , in part to avoid the negative connotations associated with the word discrimination . However, we also want to stress that price differentiation includes not only charging different prices to different customers for the same product (group pricing) but also the less controversial strategies of product versioning, regional pricing, and channel pricing.

  There is both art and science to price differentiation. The art lies in finding a way to divide the market into different segments such that higher prices can be charged to the high-willingness-to-pay segments and lower prices to the low-willingness-to-pay segments. There is no one way to segment customers that applies to all possible markets. Instead, there is a variety of techniques that can be applied in different ways, depending on the characteristics of a market, the competitive environment, and the character of the goods or services being sold. The science lies in setting and updating the prices in order to maximize overall return from all segments.

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  Pricing and Revenue Optimization

  Second Edition

  • Robert L. Phillips(Author)
  • 2021(Publication Date)
  • Stanford Business Books

    (Publisher)

  6 PRICE DIFFERENTIATION

  In this chapter we examine one of the most fundamental concepts in pricing and revenue optimization—price differentiation . Price differentiation refers to the practice of a seller charging different prices to different customers, either for exactly the same good or for slightly different versions of the same good. It can be a powerful tactic for sellers to improve profitability. It also adds a new level of complexity to pricing, often driving the need to use analytical techniques to improve the calculation and updating of prices over time. Price differentiation can also be dangerous if not managed correctly—it can lead to loss of profit through arbitrage and to negative reactions to pricing that some customers may perceive as unfair.

  Tactics for price differentiation include charging different prices to different customers (or groups of customers) for exactly the same product, charging different prices for different versions or amounts of the same product, and combinations of the two. It also includes charging different prices for combinations of products than for individual products sold separately. I use the term “price differentiation” rather than the standard economic term price discrimination in part to avoid the negative connotations associated with the word “discrimination.” However, I also want to stress that price differentiation includes not only charging different prices to different customers for the same product (group pricing) but also the less controversial strategies of product versioning, regional pricing, channel pricing, and nonlinear pricing.

  While “price differentiation” and “dynamic pricing” are often used interchangeably, there is an important distinction between the two concepts. Price differentiation refers to strategies for charging different prices to different customers based on differences in their willingness to pay. Price differentiation usually (but not always) means that different prices are in play for the same (or very similar products) at the same time. Dynamic pricing, on the other hand, refers to changing the price of a product over time. Dynamic pricing is often employed to balance supply and demand—as in the case of the variable-pricing approaches discussed in Chapter 7

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  Intermediate Microeconomics

  An Intuitive Approach with Calculus

  • Thomas Nechyba(Author)
  • 2018(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  It differs somewhat from the models in the previous two sections where we began by defining a set of possible product characteristics either along an interval of a line or along a circle on which firms choose to locate their product. In those models, we could talk about the degree of Product Differentiation between two products as the distance between the product characteristics, and we assumed that consum-ers can only choose one of the products and will choose the one whose product characteristic is closest to their ideal point. In many markets, consumers actually do not choose just one product type, but rather have a taste for product diversity. Think, for instance, of restaurants. Few of us go to the same restaurant every time we go out, but instead prefer areas with lots of different restaurants we can frequent over time. Product Differentiation in such a market cannot really be modelled with the tools we have explored thus far since those tools assumed each consumer will always pick their ‘favourite’ restaurant. The model we will present next therefore departs from the assumption that consumers consume only one good and thus choose the one that is closest to their ideal. Rather, we will model consumers as becoming better off the more choices within a market (like restaurants) they have. They will choose to spread their consump-tion in the differentiated product market across the different types of products offered. A firm i is assumed to produce a single type of product, denoted y i , and all we will say is that this product is different but somewhat substitutable with other products y i produced by other firms in the same market. Firm i might, for instance, offer Northern Italian food, while firm j might offer Chinese food. We will abstract away from degrees of prod-uct differentiation between two products in the same market and instead consider the entire market as more diversified the more firms it contains.

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  Essentials of Pricing Analytics

  Tools and Implementation with Excel

  • Erik Haugom(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Chapter 3

  Segmentation and price differentiation

  When firms face finite customer responses from price changes, they have market power. This means that they can set prices more freely compared with firms operating in markets recognized by perfect competition. The question the managers of such firms must ask is how they can use their market power to maximize profit. One important answer to this question is that they should look for ways of charging different prices for, more or less, the same product or service offered to the market. That is, firms should look for ways to price differentiate based on certain criteria . Identifying the certain criteria that can be used to price differentiate is often referred to as segmentation . Price differentiation and segmentation are at the heart of pricing analytics in general, and variable pricing specifically. This chapter is devoted to explaining the theory and practice of these concepts and why firms (always) and customers (sometimes) should both be eager to have more of it. The following topics will be covered:

  • Definitions and degrees of price differentiation.

  • The economics theory behind price differentiation.

  • Ways to segment and price differentiate in practice.

  • Challenges of segmentation and price differentiation.

  The calculations of optimal differentiated prices and the implementation of this practice in Excel will be presented in later chapters. In this chapter we limit the Excel implementation to simple examples that illustrate the impact from various approaches to price differentiation on profit.

  3.1 Price differentiation defined

  Price differentiation can be defined as:

  “The practice of charging different prices for identical or similar goods or services based on certain criteria.” 1

  A given firm can perform price differentiation if it:

  1. Can identify at least some variation in the maximum price its customers are willing to pay for the product or service of interest. This maximum price is called the reservation price.

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  Managerial Economics for Decision Making

  • John Adams, Linda Juleff(Authors)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  Every product has six basic characteristics associated with it – quality, design, performance, features, packaging and durability – and it is the combination of these which is impor-tant to the firm if it is to sell the product successfully. If, for example, a product Q4 managerial economics for decision making 208 gets a reputation for being of poor quality, then consumers will be unwilling to purchase it a second time and they will try an alternative brand instead. This can be termed the primary effect. This may be followed by a secondary effect whereby the unsatisfied customers tell other potential customers about the product’s poor quality and so effectively discourage them from buying it as well. This can be very damaging for the firm over the longer term unless it takes steps to remedy the problem which is where its product development strategy becomes important. This will be considered in the next section. The firm will use a specific combination of the six basic product character-istics in order to separate out its product from other similar ones on the market. This is known as Product Differentiation. The purpose of this approach is to influence the demand for the product by enabling the consumer to clearly identify it within the market. As in the case of advertising, this may operate in two ways – by increasing demand at every price and hence shifting the firm’s demand curve to the right or by reducing the price elasticity of demand and making the demand curve steeper. Varying the product’s characteristics may enable the firm to do this in the same way that the appropriate use of adver-tising does. In both cases, creation of a strong brand identity is basically what the firm is trying to achieve. The difference is that product policy is a matter of substance, whereas advertising is merely a means of promoting an existing product regardless of how good or bad it actually is.

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  An Economic Theory of Managerial Firms

  Strategic Delegation in Oligopoly

  • Luca Lambertini(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  7 Endogenous Product Differentiation          

  While so far Product Differentiation has appeared here and there in the form of the preference for variety of a representative consumer, this chapter focuses on the bearings of Product Differentiation formulated from the specific viewpoint of discrete choice theory (Anderson et al., 1992), where a continuum of consumers differ for some specific features (willingness to pay or location in a well behaved preference space) and express unit demands for their preferred variety of a good whose characteristics are endogenously chosen by firms for strategic reasons.

  Ever since its early stages, the theory of industrial organization has viewed Product Differentiation as a means to soften market competition, in particular price competition. Discrete choice theory obviously shares this flavour (see Gabszewicz and Thisse, 1979, 1980, and Shaked and Sutton, 1982), combining it with a renovated attention for the properties of the entry process, in whose connection the so-called finiteness property has been characterized (Shaked and Sutton, 1983).

  The relevance of granting differentiation its proper strategic nature deserves a few more words, and perhaps can be best appreciated through a more concrete example. Confining ourselves to the effects of endogenous Product Differentiation on price competition, it is worth dwelling upon a recurrent idea which may sound sensible to the casual observer but might also haunt the dreams of managers and stockholders (and in fact it has done so several times), namely, that imitating a successful product could be a fruitful strategy, especially if that product relies on secrecy rather than patent protection. Whether this turns out to work or not, essentially depends on consumers’ brand loyalty, be that motivated or not by objective considerations. The story of several industries, such as, for instance, that of soft drinks or clothing, provides plenty of examples in either direction, while the seminal debate on the so-called minimum or maximum differentiation principles (Hotelling, 1929; d’Aspremont et al., 1979) decidedly claims that firms should keep off from each other as much as possible in order to soften price competition and increase profits, much the same way as they would by sustaining implicit or explicit cartel behaviour with similar or identical products. In view of the managerial inclinations we have become accustomed to in earlier chapters, this prescription should be expected to apply a fortiori

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  A General Theory of Competition

  Resources, Competences, Productivity, Economic Growth

  • Shelby D. Hunt(Author)
  • 1999(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  Each firm competes by making the most of its individuality and its special character. It is constantly seeking to establish some competitive advantage . . . [because] an advanced method of operation is not enough if all competitors live up to the same high stan-dards. What is important in competition is differential advantage, which can give a firm an edge over what others in the field are offering, (pp. 101-2) Alderson (1957, pp. 184-97) identifies six bases of differential advantage for a manufacturing firm: market segmentation, selection of appeals, transvection, product improvement, process improvement, and product innovation. While product improvement, process improvement, and product innovation require no elaboration, the other three do. By market segmentation having the poten-tial for a differential advantage, Alderson means that firms may have an advan-tage over competitors when (1) they identify segments of demand that competi-tors are not servicing (or rivals are servicing poorly), and (2) they subsequently develop market offerings that will appeal strongly to those particular segments. On the other hand, selection of appeals recognizes that some firms can achieve advantage by the images that are conveyed to consumers through advertising and other promotional means. Similarly, transvection implies an advantage in reaching a market segment through a unique channel of distribution. The existence of a differential advantage gives the firm a position in the marketplace known as an ecological niche (Alderson 1957, p. 56). The core and fringe of a firm's ecological niche consists of the market seg-ments for which the firm's differential advantage is (1) ideally suited for and (2) satisfactorily suited for, respectively. A firm can survive attacks by com-petitors on its fringe as long as its core remains intact; it can survive at-tacks on its core as long as it has the will and ability to find another differen-tial advantage and another core (pp. 56-57).

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  Industrial Organization

  Markets and Strategies

  • Paul Belleflamme, Martin Peitz(Authors)
  • 2015(Publication Date)
  • Cambridge University Press

    (Publisher)

  5.3.1 Quality choice Product Differentiation may not correspond to idiosyncratic tastes concerning the different prod-ucts. There may exist dimensions in the space of product characteristics along which all consumers agree that one product is more desirable than the other. In this case, we refer to the quality of a prod-uct. Suppose that the quality of the product can be described by some number s i ∈ [ s , s ] ⊂ R + . Consumers agree that high quality is better than low quality but they are heterogeneous in the way 7 See de Palma et al. (1985). 8 See Salop (1979). While such a model is less suited to analyse the degree of Product Differentiation (what would be the meaning of minimal versus maximal Product Differentiation?), it is well suited to address issues of firm entry and to derive comparative statics results in a free-entry world (see Chapter 4 ). In an alternative specification with quadratic transport costs, it can be shown that the configuration with equidistant locations constitutes a subgame-perfect equilibrium in the location-then-price game (see Economides, 1989). 5.3 Vertical Product Differentiation 121 they value quality. To capture this heterogeneity, we introduce a preference parameter for quality θ ∈ [ θ , θ ] ⊂ R + . Consumers with a large θ are those consumers who value quality improvements more strongly, that is, they are more sensitive to quality changes. Again, we consider discrete choice and unit demand, so, each consumer chooses one unit of one of the products in the market. Consumers are distributed uniformly on θ , θ and consumers are of mass M = θ − θ . The utility function describing the population of consumers thus has the property ∂ 2 u ( θ, s , . . . ) ∂ s ∂θ > 0 . We capture this effect by a simple multiplicative interaction between preference parameter and quality. 9 Suppose that the direct utility for one unit of good i is u i = q 0 + θ ( s i − s ).

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