In many markets, consumers rarely view competing products as identical. Even if the features, characteristics and attributes of competing products are the same, branding may create perceived differentiation in the consumer’s mind. These thoughts suggest some key questions that firms should consider when thinking about product differentiation.
First there is the question of how consumers perceive products and services. This is another way of saying that it is really consumer preferences that determine differentiation. Heterogeneity among consumers, in terms of preferences, gives rise to differentiation – firms may choose to design products and services which serve particular bundles of consumer preferences. This implies that, in order to achieve differentiation which is valuable to customers, firms must study and understand consumer preferences.
Secondly, it is important to know the extent to which different consumers share the same preferences. Choosing to serve consumer preferences which are not widely shared may lock a firm into serving a small and static market niche. Thus, firms need to also study and understand the distribution of consumer preferences over the population of consumers who may buy the product or service being offered.
Thirdly, firms should try to understand the demand curves of the various consumers who may buy a product or service. Here, the issues of discrete choice (brand preference) and unit demand need to be considered. For example, in the car market, it is a reasonable assumption that consumers will buy a single car, but this population of consumers will have heterogeneous tastes and preferences. In other markets, however, these assumptions may not hold. For example, with beer or carbonated drinks, discrete choice is often a reasonable assumption to make, but consumers will differ in their individual demand curves.
Finally, firms should consider the extent to which consumers care for product variety. In some markets, consumers enjoy and welcome variety. For example, in the wine market, a large number of consumers actually enjoy product variety and they will buy variable quantities of product. In these cases, neither discrete choice nor unit demand are good assumptions to make.
Why are these questions important? Simply that the answers to these questions drive the assumptions that an analyst might make when attempting to model consumer behaviour and product differentiation. Overlooking these questions, or failing to address them, can result in models that are not good representations of reality. This, in turn, can result in misguided market and product strategies.