What are some advantages and disadvantage of product differentiation?

Producers’ perspective.

Product differentiation improves a product’s qualitative competitiveness (i.e. makes a product more attractive to consumers). This causes consumers to put less consideration on price when purchasing the product.

In Economics, we say that the demand for product becomes less price elastic.

When the producer has achieved this, several desirable business outcomes or strategies can be made possible:

1. The producer can increase price to increase revenue as the fall in quantity demanded isn’t as great;
2. The producer can treat the product as its “safety net” and take greater risks in developing other products (think about how Sony’s cash-cow products  have allowed it to keep pushing boundaries on its phones despite losses for such a long time);
3. As consumers get “locked in” to the product, the producer can benefit from higher sales to its complementary products (like how Apple’s products have fueled sales in accompanying dongles);
4. In addition, with a good base product with loyal customers, producers gain more leeway in “experimenting” with product features in search of increased attractiveness to consumers (further consolidating sales if things go to plan).

As with most business decisions, product differentiation carries significant risk:

1. Notwithstanding blind luck, significant investments often need to be made to realise effective product differentiation – there are opportunity costs to the money spent on market/product research which may prove critical;
2. Products can flop if the differentiation is negatively received by consumers (Windows 8 was a good example);
3. Companies can even be “locked in” to their own differentiated products, making it hard to “re-invent” themselves when need be – this was keenly felt with Japanese automakers whose label of making “reliable but boring” everyday cars stuck.

Consumers’ perspective.

It is fairly easy to imagine the upside of product differentiation to consumers: More variety, spurring more competition – repeat.

Generally more meaningful product variations allow more purchase choices, which improves consumers’ welfare accordingly.

Less obvious are its downsides to consumers:

1. Product differentiation often result in poor cross-brand compatibility. At best this results in product interfacing proliferation at home – at worst the waste generated can be truly staggering.
2. Product differentiation often force peripheral features that most consumers may not necessarily need upon them, at higher prices, ironically reducing consumers’ surplus.

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