Economic theory tells us that companies that sell the same product to the market will eventually find themselves in “perfect competition” – each with zero profit. Fortunately, this particular theory (like most others) offers us a starting point so that we can better understand reality.
Using our example of two ice cream vendors on the beach, adhering to economic theory, the vendors would be physically located next to each other in the middle of the beach, they would sell the same ice cream for the same price. No one dares to try to sell their product at a higher price than their competitor, the “gentlemen’s agreement” will be short on keeping both prices high but equal. The temptation to gain more market share reigns, “of course, one of the sellers starts the race down,” lowering its price slightly. We know how it ends.
The reality, of course, is that companies make a profit, and that’s one of the ways to achieve that Product version:.
Assumptions, which are set as part of the theoretical scenario, give way, և the market opens. For example, sellers would not sell the same ice cream because different consumers have different tastes. There is also imperfect market transparency, which means that some consumers will only know the prices of one of the sellers. Other assumptions are also made, և each plays its part in the market response.
Product differentiation is beneficial if consumer preferences are heterogeneous. Factors such as specifications (cell phones), durability (shoes), resale value (real estate), taste / image (cars), location (gas stations or ice cream vendors) և time (flights) help consumers decide which is: the choice is the best for them. Ultimately, customers determine the value of YOUR product. Not sometimes. All the time.
The product can be distinguished in two lines.
- Horizontal version – Given the equal prices, some consumers would choose product “A” and others would choose product “B”.
- Vertical version – At equal prices, EVERY consumer will choose product “A” instead of product “B”.
Going back to the beach (who does not like how it sounds), we can find an ice cream vendor who leaves in the middle. This allows it to increase its price as it is more suitable for people on one end. Seeing this, the second ice cream vendor follows the example, a little away from the middle, only in the opposite direction. This example of “horizontal differentiation” allows him to increase his prices. Every seller who now sells his product at a higher price than before, earns more profit. Supporting Factors That Positively Affect Price և Profit In this example of horizontal differentiation.
- distance of sellers from each other
- the magnitude of the consumer inconvenience due to the passage of a certain distance
- Number of consumers on the beach
Using the vertical differentiation element, let’s assume that one vendor sells premium ice cream and another sells low quality ice cream. If the prices were the same, all consumers would choose a seller with a premium brand. Knowing this, the seller of low-quality ice cream lowers his price. Assuming his costs are also lower, he can still make a profit, even at lower prices. The first seller can increase its prices, considering that its target market will pay more for a high-quality product. And so it goes, the lower end can further reduce the quality of their products (և costs), and the higher end can grow as much as their customer base will allow. The contributing factors that positively affect prices և profit in this Vertical Differentiation example are as follows:
- the difference in product quality
- the degree of heterogeneity in terms of consumers’ willingness to pay
The bottom line,: we see it all the time, is that companies that offer lower quality products can make big profits, just like companies that offer higher quality products.
Healthy exercise is for manufacturers to understand whether they can be more profitable through horizontal product differentiation or vertical product differentiation. There is a lot of real potential for even greater profit.
If you would like to discuss in more detail how this approach will benefit YOUR Company, please contact Brand performance: today!