Horizontal Product Differentiation - Essay Example

In the presence of horizontal product differentiation, there is a tension between the desire to weaken price competition and the desire for increasedmarket share. Introduction: As a corporate firm, the main aim is not just to select a product, estimate the demand and set a price for that product. Most part of the corporate strategy is focused on influencing the demand. A product and its specifications play an important role in influencing this demand from the customers. Hence firms strive to attract customers by differentiating their products and tending to closely meet the consumer requirements (Sloman and Sutcliffe, 2004). Many firms enjoy monopoly in their product segments because of the variety of products produced by them. Hence the corporate firms always tend to attain monopoly in a market so that they control the prices of the products. Product Differentiation: A product has many dimensions and attributes such as technical and quality standards, design and service characteristics. An important distinction to be considered in product differentiation is horizontal and vertical differentiation. Vertical product differentiation is “where a firm’s product differs from its rival’s products in respect to quality” (Jobber, 2004, p. 145), whereas in horizontal product differentiation, the firm tends to differentiate its products in terms of features, while maintaining the same quality. The costs of products that are produced with horizontal differences do not vary to a great extent, as the production processes are similar for these products and hence it is common for these products to have the same price. However, this differs from the customer’s perspectives. The availability of a larger variety of products will increase the chances of the customer finding the product that closely meets his requirements and hence can increase his surplus. Moreover, horizontal product differentiation will enable the firms to sell its products to new customers, by meeting their needs and this will lead to the overall growth of the company (Johnson, Scholes and Whittington, 2006). Horizontal product differentiation has made it possible for a firm to produce different products of roughly the same quality with a difference in the list of features. This will lead to the production of new products with no increase in marginal costs. Price Competition Vs. Market Share: It is imperative to note that the presence of horizontal product differentiation has led to the conflict between the objective of weakening the price competition and the objective of increasing the market share. This is made clear by applying the spatial concept of Hotelling model to the concept of product differentiation (Hotelling, 1929). The price that a customer is willing to pay for a product A is taken as V. This also indicates the utility of the product to the customer. Hence the customer will be willing to pay a price which is lesser than this value V for a product. The price of the product A is taken to be p. Assuming that the product is the only option available, the product only caters to the customers whose needs match with the exact specifications of the product. Consider the customer population to lie in the x axis and the price in the y axis. The product A can be mapped on this graph as shown below: In the graph, t represents the utility or cost to the customer for compromising one unit of his requirement. Hence the customers who are covered under pA + tx are satisfied with the product. This model is arrived at, by modifying the Spatial concept of the Hotelling model. The location variable is replaced by the market share and the transport cost t is replaced by the marginal cost to the customer. The price that the customer is willing to pay is the same in both the models. In case product A is differentiated and product B is introduced, then the optimum price for the product will be as shown below: It is evident from the graph that the two products cover more market share. Also the price can be set higher compared to the previous case. This will drive the firm out of the price competition and any other firm offering one of the products at a lower price will be preferred. If the firm decides to lower the prices of the products A and B, then there will be a overlap of the products in the two curves pA + tx and pB + tx. Hence in order to get back into the price competition, the firm has to limit to one product and reduce the price. But as stated earlier, the market share will also come down for the product. The analysis clearly indicates that there is a tradeoff between the desire to weaken price competition and the desire for increasing the market share. Thus the presence of horizontal product differentiation complicates the corporate decision making process. In the market where the competition is fierce and new firms are actively researching new segments to explore, it is very essential for a company to have a strong position in the market in which it is operating. The company should strive to keep the costs lesser and in turn, the prices also lesser, so that the entry into the segment is difficult (Johnson, Scholes and Whittington, 2006). Lower price for the product is an effective entry barrier which will eliminate new firms from stepping into the market. Hence the firms place emphasis on producing high quality products to the customers at the lowest possible price (Ireland, 1987). The firms also have to cater to the different needs of the customers in the market, in order to increase its market share. Hence the firms conduct market research and introduce products with different features while maintaining the quality. The specifications of the products can be finalized based on many factors. The common approach followed is to survey the requirements of the customers and also the amount, the customers are willing to pay for the specific features of the product. This will throw light on the market potential and the firm can identify the common basic features required by the consumers. The cost of the product can be worked out based on the surplus of the consumer and the production process can be designed to suit the costs. The features which have high production costs, but the customers are willing to pay a lesser marginal amount, then it is sensible for the company to skip these features. Many versions of the product can be brought out by the firm with different set of features (Samuels, Wilkes and Brayshaw, 2000). It is also important to note that there are many arguments about horizontal product differentiation to be an entry barrier in a segment. When a firm has a number of differentiated products, it can be said to have monopoly over the segment. However, the firm is not a price setter in this case, as the prices have to be based on consumer preferences. If the products are highly priced than the utility to the customer, then it is simpler for other firms to enter into the same market (Di Cola, 2005). There is an increased urge for all companies to take up as much market share as possible and to retain the customers for a longer period. Hence the firms thrive to maintain brand loyalty from its customers. It is essential for the firms to clearly position their products and differentiate one from another; however the prices are to be nominal (Perloff and Salop, 1985). Only then the customers will be interested in spending for the product. Conclusion: It is evident from the above analyses that firms strive to meet the customer’s requirements to a more accurate level via. horizontal product differentiation. However, care has to be taken to clearly position the product in the minds of the customers and hence it is essential to target the market segment for the product more accurately. This will lead to a tradeoff between the desire to weaken price competition and the desire to increased market share, as analyzed using the Hotelling’s spatial model. Hence horizontal product differentiation has led to increased complexity and analysis, in the management’s decision making process. Bibliography Di Cola, M. (2005), Horizontal Product Differentiation and Entry Barriers, Accessed on 07 Feb 2009, Retrieve from http://www.gredif.it/prova/Articoli/MAURIZIO%20DI%20COLA.pdf Hotelling, H. (1929), Stability in competition, The Economic Journal 39, 41-57 Ireland, N.J. (1987), Product Differentiation and Non- Price Competition, Oxford, Basil, Blackwell Jobber, D., 2004, Principles and Practice of Marketing, 4th Edition, McGraw – Hill, Berkshire Johnson, G., Scholes, K. and Whittington, R., 2006, ‘Exploring Corporate Strategy’, 7th edn, Prentice Hall, Essex Perloff, J. M. and Salop, S. C. (1985), Equilibrium with Product Differentiation, in “Review of Economic Studies”, Number 52, p 107 – 120 Samuels, J. M., Wilkes, F. M. and Brayshaw, R. E. (2000), Management of Company Finance, 6th edn, Thomson Learning, London Sloman, J. and Sutcliffe, M. (2004), ‘Economics for Business’, 3rd edn, Prentice Hall, Essex Read More