Traditional business strategy indicates that companies should choose one of two generic strategies: product differentiation or being a low cost provider. However, implementing a differentiation strategy does not mean you get a free pass on costs.
In industries such as branded pharmaceuticals and technology, the pace of innovation is rapid enough to allow differentiators to constantly introduce new products while abandoning others that become stale. Many other industries do not have the pace of change sufficient to support the introduction of new products or features necessary for meaningful long-term differentiation. In those industries, whether a differentiator survives or fails depends on whether they are the low cost provider for the differentiated value they provide to their customers.
The heart of a differentiation strategy is providing a unique offering that has value to customers. Merriam-Webster defines value as, “the amount of money that something is worth.” Accordingly, value is not the features in and of themselves, it is the amount of money those features are worth to customers.
Customers do not determine the value of your offering in a vacuum, and that value does not remain static. They are constantly making cost-benefit decisions by comparing the price and performance of your offerings against the changing price and performance of the offerings of your competitors. As a result, for any given set of features, you need to have the lowest price in your market for products or services with identical, or nearly similar, sets of features. This is the point where differentiation strategies often go awry.
Far too often, differentiators scoff at the notion of competing on price. Propose “discounting” to a differentiator, and you are likely to laughed—or thrown—out of the room. However, failing to charge the lowest price for a given set of features creates what renowned management consultant Bruce D. Henderson referred to as a price umbrella.
A price umbrella exists when a leader chooses to keep prices too high, allowing a less cost-effective competitor to coexist and grow its customer base. As that competitor grows, it generates significant experience and scale effects, resulting in lower cost structures. Those lower cost structures, in turn, allow it to offer the same features for lower prices, eventually toppling the market leader.
As a result, a sound differentiation strategy is not simply based on providing a differentiated product that justifies premium pricing, but also includes the following elements:
- Making sure your cost structure is the lowest for the features provided.
- Charging a price low enough to ensure that your growth rate exceeds that of your competitors.
- Continuously decreasing costs by capturing the benefits of experience and scale that result from growth.
- Continuously reducing prices as experience and scale effects are realized in order to avoid subsidizing the inefficiencies of your competitors.
Following these four steps creates the cycle of growth needed to maintain market leadership. For those who are not currently leaders, these four steps are the roadmap for becoming one.
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