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Product Differentiation: What It Is and How It Works
By
CAROL M. KOPP
Updated June 18, 2024
Reviewed by
AMY DRURY
Fact checked by
KATRINA MUNICHIELLO
What Is Product Differentiation?
Product differentiation distinguishes one company's products or services from its competition.
Successful product differentiation leads to brand loyalty and sales. A product differentiation
strategy identifies and communicates the unique qualities of a product or company while
highlighting the differences between that product or company and its competitors. Product
differentiation can create a competitive advantage for the product's seller and build brand
awareness.
KEY TAKEAWAYS
Product differentiation aims to direct a consumer's attention to one or more key benefits of a
product or brand.
Companies may distinguish an item through product design, marketing, packaging, or pricing.
Companies gain a competitive advantage and market share through product differentiation.
Investopedia / Sydney Burns
Marketing Strategy
Product differentiation is a marketing strategy to encourage consumers to choose one brand or
product over another. It identifies the qualities that set one product apart from similar
products and uses those differences to drive consumer choice. Differentiation marketing may
also focus on a niche market.
Differentiating qualities may be reflected in a product's packaging, marketing promotion, or
brand name. A strategy may require adding new functional features or might be as simple as
redesigning packaging. Sometimes, differentiation marketing does not require any changes to the
product but a new advertising campaign or other promotions.
The differences between products can be physical or measurable, such as the lowest-price gym in
a region. However, the differences between the products could be more abstract such as a car
company claiming their cars are the most luxurious. Product differentiation aims to alter a
consumer's interpretation of the benefits of one item compared to another. The actual difference
in the product compared with competing products might be small or nonexistent.
IMPORTANT
Companies that achieve high market research metrics for brand loyalty and customer loyalty
grow revenues 2.5 times faster than industry peers and deliver two to five times
the returns to shareholders over 10-year time frames, according to a study by the Harvard
Business Review.1
Types of Differentiation
Price: Companies can charge the lowest price compared to competitors to attract cost-
conscious buyers. However, companies may also charge higher prices to imply quality and that a
product is a luxury or high-end item.
Performance: Products can be differentiated based on their reliability and durability. Some
batteries, for example, are reputed to have a longer life than others, and some consumers may
buy the brand based on this factor.
Location or Service: Local businesses may differentiate themselves from larger national
competitors by emphasizing that they support the local community. A local restaurant, for
example, may source its food and ingredients from local farmers and purveyors.
How Consumers Choose
Vertical Product Differentiation: Consumers rank products based on an objective,
measurable factor, such as price or quality, and then choose the most highly ranked item.
Although the measurements are objective, each customer chooses to measure a different factor.
For example, a restaurant might top one customer's list because their meals are vegetarian.
Another customer might choose a different restaurant because the meals are less expensive.
Horizontal Differentiation: Consumers choose between products based on personal
preference and subjectively. For example, a customer who buys a vanilla milkshake over
chocolate depends on their taste. The milkshakes are objectively priced the same with similar
ingredients, but the consumer chooses based on personal preference first.
Mixed Differentiation: More complex purchases tend to consider a mix of vertical and
horizontal differentiation. When buying a car, for example, a consumer may consider safety
metrics and gas mileage, both objective measures and examples of vertical integration. However,
the consumer will likely want a specific color, an example of horizontal differentiation.
What Is an Example of Product Differentiation?
An example of product differentiation is when a company emphasizes a characteristic of a new
product to market that sets it apart from others already on the market. For instance, Tesla
differentiates itself from other auto brands because their cars are innovative, battery-operated,
and advertised as high-end.2
What Is the Difference Between Functional and Nonfunctional Features
in Differentiation Marketing?
When functional aspects of two products are identical, nonfunctional features can be highlighted.
Differentiation marketing can help companies stand out when a product isn't perceived as much
different from a competitor's, such as bottled water. The strategy might be to focus on a lower
price point or that it's a locally owned business. The strategy can be an appealing change in
design or styling.
Why Is Product Differentiation Important?
Product differentiation allows different brands or companies to gain a competitive advantage in
the market. If differentiation were unachievable, the bigger companies with economies of scale
would always dominate the market because they can undercut smaller producers in price.
The Bottom Line
Product differentiation allows products and brands to command market share based on consumer
preferences. Customers choose products for price, brand image, quality, durability, taste, color,
or a temporary trend. If a product can differentiate itself from its competitors and appeal to
consumers, it will have a competitive advantage.
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