The firm attempts to differentiate itself from the pack by offering something that is perceived by the industry (and its customers) as being unique. It could be the right quality (Rolls Royce or Mercedes Benz), innovation (Hewlett Packard), or the willingness to be flexible in product design (Ferrari or Maserati). All these examples of quality, innovation, and flexibility have extremely important implications for the production system and the way it is designed and managed. The requirement is to be flexible in order to cope with the demands on the system. Brand image is important to this strategy. There may be other ways that an organization differentiates itself; for example, a strong dealer network (Zenith), an extremely well designed distribution system (Gillette or Hunt Wesson), or excellent service.
This strategy does not ignore costs, just as the cost leadership strategy does not ignore quality, but the central thrust of the productive system and, indeed, of the entire organization is on the unique character of the company’s products and services. Cost and availability are less important in the company’s priorities since customers may be willing to pay a little more and even wait in order to have a more unique product.
In relation to industry competitors, a company with a differentiation strategy has less competition from both its direct competitors and from potential substitutes because of the uniqueness of its position. Its customers have greater brand loyalty and, therefore, less price sensitivity. Differentiation draws higher margins, so the higher costs are less important. Barriers to entry are provided and higher margins make potential competition from suppliers’ forward integration less important.
Still there are risks. Customers will tolerate only some maximum premium for uniqueness. If cost control becomes lax or if the cost of providing the uniqueness is beyond the customers’ willingness to pay, then advantage can turn to disadvantage. Since many of the ways of providing high quality, innovation, and flexibility are labor intensive, inflation in labor costs relative to the inflation in the costs of other factors can price the product out of the market.
Market segmentation is developed in terms of meeting the special needs of a particular market, providing lower cost for that market segment, or both. Whereas the first two strategies are industry wide, market segmentation focuses on a particular customer group, a segment of the broad product line, a geographic portion of the market, or some other profitable niche of the market. It selects a market segment on some basis and tries to do an outstanding job of serving that market. The industry wide leaders cannot serve all segments of the market equally well, so there are important niches for specialists. Perhaps, everyone but the industry leaders should be looking for a comfortable but viable niche.
The segmentation strategy can take an approach that combines one of the first two strategies with it. For example, a supplier of Sears for a particular appliance must undoubtedly have a low cost sub strategy in order to meet the requirements of the nation’s number one retailer.
Another example is the firm that limits itself to small special orders within an industry dominated by giants who cannot serve this market niche very well. Yet, there may be a substantial market for small special orders. In order to serve this segment of the market, manufacturing facilities must be flexible enough to handle all types and sizes in small volume. There must be frequent changeover of machines for the many different types of orders that flow through the shop. The equipment must be flexible enough to handle the variety.
Therefore, although segmentation can emulate either of the first two strategies in a more limited way, it is unlikely that a firm using could ever achieve the market share of the industry leaders who are attempting industry wide strategies. The segmented firm is likely to be smaller, perhaps lacking the financial resources to attempt an industry wide strategy.
The segmented firm need not compete directly with the giants of the industry. It may, however, have more of a problem dealing successfully with suppliers because it does not have the leverage of a large producer, and it may be more of a target of forward integration from suppliers and backward integration from customers.
Finally, not all industries seem to have opportunities for all three strategies. For example, in most commodities, cost and availability are the only factors of importance. In industries where entry barriers are low and exit barriers high, the competition may be so intense that the only feasible strategies are either differentiation or segmentation.