And yet, companies must differentiate. There is overwhelming evidence from across many industries to suggest that differentiation and profitability are positively correlated. I’d go so far as to suggest that if you show me a company that makes above-median profits in their category, I’ll show you a company that is well-differentiated from competition on one or more dimensions.
There are more options available to companies than purely product-feature differentiation. I’d assert that product-based differentiation is most effective as a strategy during the formative years in any new category. I wrote in an earlier posting about Apple’s iTunes, and my belief that it was iTunes, and not the iPod, that was so well differentiated as to create a sustainable position for Apple in the emerging digital music arena a few years ago. But as markets mature, in order to disrupt the position of a well-entrenched or product-differentiated leader, companies must look to non-product-based differentiation.
As product categories grow, I believe they hit “false maturation” points. This is when it looks to all of the established players as if the rules are clear, and then someone or something changes all of the rules. Business model differentiation is usually what brings about this change. Dell Computer changed all of the rules on how PC’s get manufactured and delivered to the customer, resulting in a set of advantages to them on product cost and mass customization for the customer, that sustained them for years, and earned them the lion’s share of profits in their category. Superior business models, ranging from how a company produces products and services, to how it conducts business with its suppliers and partners, to changes in the distribution model, usually result in lower costs for the innovator, and often result in sustainable differentiation on either lower-costs, better customer experience, or superior availability of products, or all three.
By “availability”, I’m referring to how easy the product is to buy. Is the product or service offered where the customer prefers to shop? Does it intercept the customer and create opportunities for unplanned purchases? Is there a sustainable advantage in the availability strategy of the company? As I write this post, I’m at an airport. It strikes me that Thomas Cook has an availability strategy. It seems like every time I get off the plane, they are right there in the most convenient spot offering me currency exchange services. It’s an otherwise commoditized market, but I’ll bet they get above-median profits based only on being in the right places.
As a society, we’re moving beyond the “stuff” economy. As a result, sometimes even price, availability, and business-model superiority isn’t enough. As services and “experiences” increasingly become the sources of growth in our economy, differentiation in these areas becomes more and more important. I recently met and spoke with Joseph Pine, co-author of “The Experience Economy” and a number of other books. Mr. Pine asserts that there has been a progression in our economy from away from products and toward not just “services”, but toward “experiences”. I agree. Arguably, companies like Starbucks, W Hotels, Disney, Lexus, and many others have built massive growth engines based in part on staging experiences for customers.
So how does all of this affect the differentiation options available to a company in a maturing market? I think of differentiation on four dimensions (see illustration).
To me, differentiation happens on the four dimensions of Product Offering, Customer Connection, Business Model, and Availability. The best companies sustainably out-pace their competition in more than one dimension, or else, really dominate in the one dimension that is most important in their category. In the illustration above, the oval denotes the position of a company that is very undifferentiated in product or customer connection, but very differentiated in business model, leading to sustainably low costs, and in availability. In this case, which might represent a computer company such as Acer, the company reinvests cost advantages to create distribution (availability) advantages.
In contrast to that example, some companies focus on product differentiation. Clearly, product differentiation remains an important dimension. But in my view, it is changing in nature. Today, product differentiation is less and less about rational features and more and more about intangibles. Products that are well differentiated make us FEEL something. Their features may be differentiated at a rational level, but the real magic comes when those features, taken together, add up to an emotional benefit for the customer. The best products resonate with our idea of ourselves, and how we want others to perceive us. This is one of the most powerful drivers of product-differentiation-based profits.
BMW comes to mind. I don’t own one, but I have driven one. Arguably, this is a differentiated product experience, driven by a number of rationally differentiated features. But more importantly, the differentiation flows from how the company translates those features into an emotional benefit. The product, and its selling proposition of “The Ultimate Driving Machine” are well-synchronized, and as such, the brand feels authentic in its promise. The result? BMW’s have the ability to make the customer FEEL something.
Customer Connection is a challenging one. It is easy to set-out to deliver it, and hard to actually accomplish it. The companies that do this best have been successful, against strong odds, at ingraining a customer-connection culture into every aspect of their companies. Done well, a sustainable profit advantage can emerge. Amazon comes to mind. There were several different aspects to Amazon’s strategy that resulted in their success, but the most obvious one to me, as a user, is their (unlikely) ability to create an intimate relationship with me, even as an e-commerce company. Because they keep such a good profile on me, and provide me with useful recommendations, and make it easy to shop (and even easier to buy), I come back time and again. In fact, I usually ONLY go to Amazon, and choose online alternatives only if they don’t have what I am looking for. Somewhere, something about the experience made me loyal – I call this Customer Connection.
Zappos (the online shoe retailer) may be an even purer example of Customer Connection. They really have nothing going for them except their ability to delight customers with a great experience. Shoes are hard to shop for without touching them and trying them. And yet, Zappos thrives, based on an end-to-end passion for customer connection. Their buying experience simply isn’t matched by anyone else in their space.
So, companies can differentiate and drive profitability based on sustainably out-pacing competitors on one or more of the four dimensions – 1) a differentiated product offering that motivates customers, ideally on both a rational and emotional level, 2) a disruptive business model that results in sustainably lower costs, translating to pricing advantages, 3) a better strategy than competition on availability and distribution, outpacing competitors on putting the product right where the customer is likely to buy, and 4) a level of customer connection that competitors can’t match, usually based on offering customers experiences that they value, and will come back for again and again.
But how does a company choose? In my opinion, three factors play into the decision: 1) What are the customer needs and benefits in the category that really motivate purchase? In other words, at the moment of truth, what do customers really value enough to sway their decision? This is easy to ask, but answering it accurately is an art form. Traditional “customer unmet needs” research doesn’t do the trick. I’ll comment more on this in another posting sometime. 2) What is the competition doing? Do they have well-staked claims? Are established, well-run players already famous for certain differentiated positions? Are their competitive vulnerabilities? And 3) What is special about our company, and our capabilities? What can we sustainably deliver that out-performs the competition? The answer lies at the intersection of these factors (see figure).“Sustainably” was the key word in #3, above. The trick to identifying a defendable position lies in figuring out whether it can be held over time. Will the competition be able to switch gears and neutralize us? If it is product or customer experience-based differentiation, the answer depends partly on the company’s ability to execute. How long will it take to become “famous” for the proposed positioning? I’d argue that right now, it would be difficult for a new online shoe retailer to position around customer experience and depose Zappos. They can sustainably defend their position, because they grabbed it early in the category’s life and executed like hell. The question for a company like Zappos is not whether they can defend their position, but rather whether their position is really important at the moment of truth. Do customers really value it, more than they value walking into a traditional store? The answer seems to be yes, for enough customers to give them a viable business.