Transcript ProDif
PRODUCT DIFFERENTIATION FROM AN INDUSTRY PERSPECTIVE Instructional Goals You will understand: • How product differentiation increases market power • The social benefits and costs of product differentiation Product differentiation is based on two fundamental premises: 1. A brand exerts greater constraint on a second brand's price when they are perceived to be close substitutes 2. Products/services are differentiated because consumers think they are different. Assumptions Standard This class Consumers have Consumers have preferences for goods or preferences regarding services per se — attributes that can characteristics of those bundled in an infinite goods are known and, variety of ways — the implicitly, invariable. majority of which have not yet been discovered. Products as points along a dimension (or attribute space), • The closer two products are to each other in attribute space, the better substitutes they are. • Individual satisfaction levels decrease with the distance from the optimal node Consumer Satisfaction: Attribute space/Location model/S&D model If consumers were spread out equally along a single dimension and if they could support only 2 brands, A&B, the social optimum would look like: The market equilibrium would look like: Is Product Differentiation Socially Inefficient? • It is a MESSY process • Not an inefficient one • Some PRODUCT DIFFERENTIATION is wasteful, but, on balance, the process appears to produce more BENEFITS than COSTS The Costs & Benefits of PD • Product differentiation raises costs – R&D costs – Increases transaction costs – May increase production/delivery costs • Product differentiation increases consumer satisfaction (measured in terms of willingness and ability to pay) Market Equilibrium w/o PD Maximum PD UVIJKLMNOPABCDEFGHQRST Product differentiation is consistent with "dynamic equilibrium" -- for the rate of investment in all things, even product development, to rise towards the level at which this investment yields only a normal return. Rivals imitate or produce close substitutes to innovator's product. Demand becomes more elastic. Organizations reduce markups of price over marginal cost (p - mc)/p = 1/|e|. If markups are not big enough to recover fixed costs, producers must exit the market or create new products that have less elastic demands.