Differentiation Advantage OUTLINE The nature of differentiation Differentiation and segmentation Analyzing differentiation: the demand side Analyzing differentiation: the supply side Bringing it all together: value chain analysis 23

The Nature of Differentiation DEFINITION: Providing something unique that is valuable to the buyer beyond simply offering a low price. (M. Porter) THE KEY IS CREATING VALUE FOR THE CUSTOMER TANGIBLE DIFFERENTATION Observable product characteristics size, color, materials, etc. performance packaging complementary services INTANGIBLE DIFFERENTATION Unobservable and subjective characteristics relating to image, status, exclusively, identity TOTAL CUSTOMER RESPONSIVENESS differentiation not just about the product, it embraces the whole relationship between the supplier and the customer. 24

Differentiation and Segmentation DIFFERENTIATION: is concerned with how a firm competes within a market. SEGMENTATION: is concerned with where a firm competes within a market. Does differentiation imply segmentation? Not necessarily, depends upon the differentiation strategy: BROAD SCOPE DIFFERENTIATION: Appealing to what is in common between different customers (McDonalds hamburgers, Honda cars, Sears) FOCUSED DIFFERENTIATION: Appealing to what distinguishes different customer groups (BMW, Doc Marten footwear) 25

Differentiation vs. Cost Leadership as a Basis for Sustained Competitive Advantage Highest returns to shareholders among the Fortune 200, 1990-2000 Av. annual return (%) Av. annual return (%) Cisco Systems 73.4 Microsoft 35.4 Oracle 65.1 Safeway 35.2 Solectron 61.7 Freddy Mac 34.8 Dell Computer 56.9 Washington Mutual 34.4 Best Buy 51.3 J.P. Morgan Chase 33.3 Applied Materials 49.8 Pfizer 32.1 Sun Microsystems 45.2 Lowe’s 31.6 Merrill Lynch 41.1 Enron 31.3 CitiGroup 40.8 Walgreen 30.7 Intel 38.2 Wells Fargo 30.1 Goldman Sachs 38.2 Cigna 30.0 General Dynamics 38.1 Cardinal Health 29.6 Texas Instruments 36.3 Tech Data 29.4 UnitedHealth Group 35.7 Houshold International 29.4 QUESTION: Which is the primary basis for competitive advantage in the above companies: cost or differentiation? 26

Differentiation and the Product Life Cycle New packages of hardware and software introduced Augmentation: repackaging of hardware and software SYSTEM Desystematization: some packages unbundled PRODUCTS & SERVICES PRODUCTS & SERVICES Decommoditization Commoditization COMMODITY 31

Analyzing the Demand Side Techniques for analyzing product attributes and positioning: Multidimensional Scaling Conjoint Analysis Hedonic Price Analysis 27

Differentiation in Pain Relievers: Multidimensional Scaling of Competing Products in the U.S. High Tylenol Low High Bufferin EFFECTIVENESS Bayer Private label aspirin Anacin Excedrin Low GENTLENESS 28

Identifying Differentiation Potential: The Demand Side What needs does it satisfy? THE PRODUCT What are key attributes? FORMULATE DIFFERENTIATION STRATEGY Select product positioning in relation to product attributes Select target customer group Ensure customer / product compatibility Evaluate costs and benefits of differentiation Relate patterns of customer preferences to product attributes By what criteria do they choose? THE CUSTOMER What price premiums do product attributes command? What motivates them? What are demographic, sociological, psychological correlates of customer behavior? 29

Differentiation of Hardware and Software SUPPORT (SOFTWARE) Differentiated Undifferentiated SYSTEM PRODUCT SERVICE COMMODITY Differentiated MERCHANDISE (HARDWARE) Undifferentiated 30

Consistency of Differentiation Strategy: Product Integrity Key to successful differentiation is consistency of all aspects of the firm’s relationship with its customers. Product Integrity: the total balance of product features Internal integrity: consistency between function and structure External integrity:fit between the product and the customers’ objectives, values, lifestyle etc.. 32

Problem of Quality in Experience Goods: A “Prisoner’s Dilemma” The problem of experience goods : quality can only be ascertained after purchase. Hence: Prisoner’s Dilemma:- Producer’s strategies High quality Low quality High 7 10 Consumer’s price 7 -5 strategies Low -5 3 price 10 3 Equilibrium reached with consumer paying a low price for a low quality item. If producer can signal quality--- both consumer and producer can move to preferred position: high quality product carrying a high price Note: In each cell, the lower left number is the payoff to the consumer and the upper right number is the payoff to the producer. 33

The Impact of Quality on Profitability ROI (%) Relative Price Relative Direct Cost 19 28 38 107 107 108 104 103 101 Relative product quality Low 33% 67% High Relative product quality Low 33% 67% High Relative product quality Low 33% 67% High 14 20 28 103 104 104 104 102 100 7 16 23 101 101 102 104 102 100 Low 25% 60% High Relative market share Low 25% 60% High Relative market share Low 25% 60% High Relative market share Conclusion: Increases in quality add more to price then they do to cost. 34

Using the Value Chain to Identify Differentiation Potential on the Supply Side MIS that supports fast response capabilities Training to support customer service excellence FIRM INFRASTRUCTURE HUMAN RESOURCE MANAGEMENT TECHNOLOGY DEVELOPMENT INBOUND OPERATIONS OUTBOUND MARKETING SERVICE LOGISTICS LOGISTICS & SALES Unique product features. Fast new product development Customer technical support. Consumer credit. Availability of spares Quality of components & materials Defect free products. Wide variety Fast delivery. Efficient order processing Building brand reputation 35

Service & technical support Identifying Differentiation Opportunities through Linking the Value Chains of the Firm and its Customers: Can Manufacture 1 Inventory holding Service & technical support Manufacturing Purchasing Design Engineering Distribution Sales 5 2 3 4 Inventory holding Purchasing Processing Distribution Marketing Canning Supplies of steel & aluminum CAN MAKER CANNER 1. Distinctive can design can assist canners’ marketing activities. 2. High manufacturing tolerances can avoid breakdowns in customer’s canning lines. 3. Frequent, reliable delivery can permit canner to adopt JIT can supply. 4. Efficient order processing system can reduce customers’ ordering costs. 5. Competent technical support can increase canner’s efficiency of plant utilization. 36