Cambashi blog

Posted on 19 Oct 2011 by The Manufacturer

The latest blog from industry IT analyst firm Cambashi looks into product differentiation and the manufacturer's role in establishing unique selling points.

When we buy a commodity, like petrol, we almost always decide where to buy on some combination of convenience and cost. The supplier with the ability to be the lowest cost provider will achieve the highest returns. That also usually means high volumes to obtain economies of scale in production and procurement.

For most manufacturers, this is not an attractive proposition. It is not just a question of labour costs.
The business model is unstable. High volumes with wafer thin margins mean always be living on a knife edge. A misstep could easily lead to bankruptcy. A better business model for manufacturers is to add considerable value to the materials and parts that go into their products.

The business strategy to avoid commodity markets is to offer products and services with product differentiation. This concept has been around in economic theory since the 1930’s and are complementary to the marketing concept of a Unique Selling Point or USP.

Several business initiatives implement this strategy. They all involve the manufacturer analysing their customer proposition; identifying the core values that differentiate it; accentuating them; and then promoting the differentiation to customers. Initiatives include:

•Investment in automation to produce core components at high volume and low cost

•Outsourced manufacturing of non-core components of the product to specialist low cost manufacturers.

•Increased volumes to improve pricing power with suppliers of non-core components

•Increased promotion to accentuate a small product differentiation

•Sustained investment in product and service innovation

But some of these initiatives are difficult to sustain.
If an enterprise out-sources manufacture to lower labour cost regions, what stops competitors using the same supply chain? If the labour is unskilled surely it would be more cost effective to invest in automation? If the labour is skilled it will be internationally mobile and before long costs adjust to global prices.

Pricing power and price setting can also be dangerous strategies. It is very difficult for any one enterprise to sustain that advantage without becoming monopolistic or part of a cartel. Government regulation would then intervene to protect the general consumer interest.

Regulation often appears to inhibit product differentiation. Back in the 1930’s economists discussed the corollary to product differentiation, the concept of perfect competition. Perfect competition describes markets where no participant is large enough to have the market power to set prices of homogeneous products.

Regulators aim for perfect competition but the key point is that they regulate what they see as homogeneous product markets. Product differentiation, from product and service innovation to provide the customer with a different, better experience will mean that it will not count as part of the homogeneous market. Indeed, regulation provides for this in that patent protection is available for innovation. Though we note that it is relatively cheap and easy to obtain a patent and much more expensive and difficult to go to court and win a case against a competitor that may have infringed it.

We argue that product differentiation is best obtained by product and service innovation. Constant innovation means that the competitors are always followers. Regulators will not pester innovators (so much). Marketing promotion will be more efficient and effective.

Management attention will need to focus onto the research and development; production; and marketing; of the differentiating elements of the proposition. It sounds simple, but implementation will probably require staff training and breaking down barriers internally and externally.

The next question, addressed in the next posting to this blog, is to ask how enterprise software applications help managers to implement a product differentiation business strategy.