Product Differentiation: Strategies, Competition, and Value
Products can be differentiated in three primary ways: by style or type (e.g., food at fast-food outlets, clothing in a store), by location (closer or farther), or by quality. Consumers differentiate products based on their willingness to pay for better quality, allowing producers to offer low-quality, cheap options alongside high-quality, premium-priced products. Industries with differentiated products exhibit two key characteristics: competition among vendors and the advantage of diversity.
Competition Among Competitors
Even if sellers of differentiated products don’t offer identical goods, they compete within a defined market. Increased market entry leads to decreased sales per company, regardless of price.
The Advantage of Diversity
This reflects the benefits consumers gain from the proliferation of differentiated products, including greater variety, convenience, and quality options.
Disputes Regarding Product Differentiation
Advertising’s effectiveness is evident in corporate spending. However, the core questions are why it works and whether it represents a societal waste of resources. In industries with product differentiation, companies advertise to increase product demand. A firm in a monopolistically competitive situation prefers to sell an additional unit at the current price, thus using advertising to boost demand and strengthen market power.
Advertising is valuable when it provides useful consumer information. However, advertising solely aimed at selling a product is more complex (e.g., a sports star endorsing a cologne). Either the consumer is irrational (believing the athlete uses the advertised cologne), or expensive advertising acts as an indirect signal, implying high product quality in a market where consumers have good information.
Some companies create trademarks, names owned by a company to distinguish its products. A company’s trade name can be its primary asset (e.g., McDonald’s).
The economic value of a trademark is not always clear. Trademarks can convey real information and guarantee consistent product quality (e.g., knowing what to expect at any McDonald’s). However, they can also create unjustified market power.
Ultimately, advertising and trademarks have economic value when they provide useful consumer information but waste resources when their sole purpose is to create market power. In practice, they likely serve both functions: providing economic value and wasting resources.