Differentiation rests on uniquely creating customer value. The economic rationale for differentiating is that the value perceived by the buyer must exceed the costs of differentiation. A differentiation strategy aims to create the widest possible gap between the unique value created for the customer and the cost of providing that uniqueness through the firm’s value chain. Put another way, a firm pursuing a differentiation strategy may have a higher average cost of production curve, but its pricing is also higher as it the unique value being offered can command a price premium.
There are two possible routes to differentiation. A firm may differentiate by performing its existing value chain activities in a unique way, or it may reconfigure its value chain in a way which creates uniqueness.
The first route requires that a firm first identify the drivers of uniqueness and then find ways to execute these in an inimitable way. The second route requires a firm to choose the configuration of value chain activities that create diistinctive value for the customer. In either case, the gap between the customer value created and the cost of differentiation must be as wide as possible.
Practically, differentiation arises out of identifying the set of capabilities that a firm must possess in order to build and deliver customer value. Capabilities are not assets. Rather, a capability is a way to ensure a desired customer outcome. A capability is a combination of processes, skills and competencies, tools, and organization that works together to achieve a desired result. A firm’s set of capabilities must support its overall corporate strategy by defining the things that the firm must excel at to create and keep customers. Differentiation can be achieved by establishing unique capabilities which create superior value outcomes for customers.
Too many firms get into the details of improving their value chains without first taking time to define and formulate their startegy for competing effectively through value creation. The strategy should define the capabilities required, which in turn help define the value chain configuration. Improving your existing value chain outwith the context of strategy and capabilities assumes that your value chain is creating and delivering unique value for customers – an assumption that may not be true.
Competing through a cost advantage is really a form of differentiation, although a special one. A cost advantage competitor achieves the lowest cost structure in their industry and is able to offer pricing which is lower than the competition. While cost advantage can be enabled through economies of scale in some industries, it is more common to achieve it through reconfiguration of capabilities and the value chain.
Differentiation is critical for superior performance. If a firm cannot build unique value for customers, the only thing it can alter is pricing. Put another way, if you are not different, you had better be cheap!