In this article we will discuss about the sources and importance of product differentiation.

Product variation refers to any change that alters ‘the physical characteristics of a product’ or ‘the conditions under which it is sold’ like changing the colour of a toothpaste tube. This is done by firms to raise their market share of a product. Consider, for example, the market for motor cars. The cars offered by suppliers range from the relatively cheap, ‘popular’ models like Maruti to the high priced quality cars like Ceilo or OPel Astra.

In the USA within the popular range there are models which are reasonably close substitutes so that a potential car buyer would review their merits and demerits before making final decision to purchase. Thus, it is possible to say that there are two markets for cars—a popular and a quality market. But in-between these two extremes there are other cars with varying qualities of performance and price.

Sources of Product Differentiation:

The sources of product differentiation are many:


(i) The first and most obvious is where one product is physically different from another. This may be due to differences in design and construction or in the materials used. Thus, T.V. sets offered by different suppliers will have variations in shape, size and look which make them recognisable one from another.

(ii) Secondly, some physical differences may affect standards of perform­ance. Better quality materials or greater precision of finish as in the case of Allwyn Prescold refrigerators may mean a longer life for the product. Better design may make it easier to maintain a product. This reduces running cost.

Such features are balanced against price differences in the minds of consumers in making their final decisions. However, some of these physical differences may be irrelevant to the functional performance of the product. A consumer is often ignorant about the quality of a product. An objective assessment of a product requires considerable technical knowledge.

(iii) Moreover, with the sale of a product goes a ‘package’ of services. Some retail shops provide credit to customers. In case of sales of durable goods like cars, promptness of after-sales services is important. There may be opportunity for returning or exchanging unsuitable goods like ready-made garments. These are planned differences in the product.


(iv) Furthermore, the sale of many goods are accompanied by the offer of ‘free gifts’ in a variety of forms. Examples include gift coupons, compe­titions with attractive prizes (as in the case of washing powders like Surf or Nirma) and providing advertisement support through sponsored pro­grammes (e.g., Sahara India Ltd. has been promoting cricket tournament in Canada). These are all short-term sales promotion measures.

(v) Another source of product differentiation arises from the different locations of buyers in relation to sellers even in case of identical products.

Two conditions must be satisfied for such local discrimination:

(a) Buyers must recognise the differences between the various sources of supply in delivery or collection costs, either in terms of money or convenience.


(b) Buyers must be required to pay the full delivered costs of the goods supplied by each seller.

In the words of Noel Branton, “The impact of product differentiation on market structure depends on the ability of some firms to secure strong advantages over others in this field. This may be the result of heavy advertising and other forms of sales promotion.”

Importance of Product Differentiation:

Regarding the importance of ‘product differentiation’ the following two points may be noted:

(a) Product differentiation often acts as a barrier to entry of new firms into the industry. It may also be noted that advertising enables a firm to achieve product differentiation.

Thus advertising, as Lipsey has pointed out, act as an empty barriers. Well-established firms possess an advantage. They turn out products which are already known to the customers as compared with new unknown products. New firms will have to reduce their prices or improve the quality of their products considerably to enter an industry.

These may impose losses upon them. If people judge quality by price, the new products may be branded as inferior to the established ones. Alternatively, a newcomer may have to incur heavy sales-promotional expenses to try to sell within the prevailing price range.

(b) Profitable product variation may go in various directions. A producer might find that a costly change in his product would increase demand for his output. (For example, a petrol station may moves from cheap location to one that is more expensive, but also more convenient for its customers.) Or he might find that downgrading his product would lower his costs more than it would lower demand for his product and would increase his profits. For example, many producers try to maximise profits by cutting their prices and offering discounts (They provide no credit and little sales help).