The firm has at its disposal four main strategic variables, which marketers call the four P’s—namely, price, promotion, product quality, and place of sale. We have looked at pricing in some detail in Chapters 9 through 12. Promotional expenditures, or advertising, was the subject of Chapter 13. We turn now to product quality. Place of sale can be discussed in this context as well, since product quality refers to the presence of desirable attributes in the product, and from the buyer’s viewpoint place of sale translates to convenience of seller location, which is an attribute the buyer considers in the purchasing decision. 1
In the pricing and advertising chapters we assumed the existence of a product with known attributes, and we were concerned with the optimal pricing and advertising of that product. In this chapter we go back one step further, prior to the production of the product, and consider the optimal design of the product before it is introduced to the market. That is, we consider what attributes should or should not be designed into the product in order to best serve the firm’s objective function. We use the word “quality” as an index of the presence of desirable attributes in the product. Better-quality products include desirable attributes that are absent in lesser-quality products. Better-quality products also include larger amounts of desirable attributes than lesser-quality products do. For example, more fuel economy is preferred to less, and more durability is preferred to less, other things being equal.
Just as in the advertising chapter we were able to consider the joint determination of price and advertising, we shall in this chapter consider the joint determination of product quality, price, and advertising strategy. Considering all three strategies to-
gether, in a “systems” approach, is preferable to considering them separately, since there may be a synergistic relationship among these three strategic variables. 2 Our approach in earlier chapters—treating price separately while holding advertising and quality (and all other variables) constant, and later allowing price and advertising expenditures to vary while holding quality constant—was necessary for simplicity of exposition at those points. We are now ready to consider the firm’s combined quality/ price/advertising strategy.
We shall consider product quality, as well as the joint determination of quality, price, and advertising, within a framework introduced by Michael Porter in his two recent books Competitive Strategy and Competitive Advantage . 3 In short, Porter contends that the firm should choose a well-defined “competitive strategy” in order to achieve “competitive advantage.” A competitive strategy will include a combination of values for the firm’s strategic variables (in this case limited to quality, price, and advertising), that best serves the firm’s objective. 4 The firm’s objective, Porter contends, should be the attainment of a “competitive advantage.” Competitive advantage is evidenced by the firm earning greater profit than others in its industry, not just momentarily or occasionally, but on a continuing basis. This superior and sustained profitability will, of course, serve to maximize the firm’s net worth. Although these superior profits may attract the attention of potential entrants, Porter argues that achieving competitive advantage operates to inhibit entry of new firms, and if entry does occur, the firm is insulated from competition from entrants to a large degree, and in any case holds an advantage over the other firms in competing against any entrants.
Porter identifies three generic competitive strategies. (“Generic” means that they can be pursued in any market.) One is the “cost leadership” strategy, where the firm strives to be the lowest-cost supplier and thus achieve superior profitability from an above-average price-cost margin. A second strategy is the “differentiation” strategy, where the firm strives to differentiate its product from rivals’ products, such that it can raise price more than the cost of differentiating and thereby achieve superior profitability. Finally, there is the “focus” strategy, whereby the firm concentrates on a particular segment of the market and applies either a cost-leadership or a differentiation strategy. We shall consider each generic strategy in turn and examine the implications of each for product design, pricing, and advertising.
The cost of information to consumers (when they attempt to evaluate the quality of the product) is a major determinant of the optimal competitive strategy. This issue was introduced in Chapter 10 and was later discussed in the context of new products in Chapter 11. Essentially, products can be categorized as “search,” “experience,” or “credence” products, based on the difficulty and expense that a typical consumer faces when attempting to evaluate the quality of the product. In a nutshell, “search” products are typically prime candidates for a cost-leadership strategy, whereas “experience” and “credence” goods are typically best marketed using a differentiation strategy.
Nevertheless, within any market the firm has a choice of a cost-leadership, differentiation, or focus strategy; its selection will also depend on the strategies already adopted by its rivals. For example, in a market for “experience” goods one or more firms may have significant product differentiation advantages, leaving cost leadership as the optimal strategy for the firm to pursue in that market in order to attain competitive advantage. Or, in a market for search products, one or more of the other firms may be competing vigorously for cost leadership, and the firm’s best strategy may be to adopt a focus strategy, differentiating its product to best serve a particular segment, or niche, of the market, for example.
The strategy of cost leadership requires the firm to seek the position as the lowest-cost firm in the market or, at least, one of the low-cost producers. It may achieve cost leadership by vigorously promoting sales to benefit from the learning effect in production, economies of plant size, or pecuniary economies (quantity discounts for buying materials in larger quantities). To keep costs at a minimum, the firm will also need to continually incorporate the latest technology into its production process. Sales can be promoted both by promotional pricing and by advertising, of course, so the cost-leadership strategy has implications for the price and advertising strategies of the firm. What implications does it have for the product design strategy, or quality decision, of the firm?
To answer this question, let us first consider the circumstances under which a
cost-leadership strategy is likely to be the firm’s optimal competitive strategy. We can discuss these under two main headings: when the product is a search product and when the role of cost leader is vacant or may be usurped, regardless of product type.
■ Definition: Search products are products containing primarily attributes that are readily discernible by consumer information-search activity, and these search attributes form the basis for the consumer’s purchasing decision. Weight, length, and color are search attributes, but so too are attributes that can be found out for the asking. For example, the attributes of stereo equipment, like the signal-to-noise ratio, the presence or absence of the Dolby noise reduction system, and the power per channel in watts, can be ascertained (and compared with rival products) given relatively little search cost on the part of the consumer. Similarly, the attributes of primary interest to a person wishing to take an airline flight, such as time of departure, type of aircraft, number of stops en route, meals, and movies, can be found out simply by asking a travel agent or the airline check-in person. 5
Since search products are easily evaluated by consumers, they are easily compared by consumers. Consequently, if a firm’s product does not measure up to the competition, it will not retain its market share at a similar price level. The firm must compensate for the lack of desired attributes by reducing the price, or it must proceed to redesign the product such that it is more competitive on the basis of quality. As a result, the firm will feel pressure to emulate the best-selling rival products in order to produce a product that has all the features other products have and does all the things that rivals’ products do, since a product that is inferior will readily be identified as such by consumers and quickly lose sales to superior products.
If competition from rival firms forces suppliers to match each other’s search attributes, differentiation may still take place on the basis of any experience or credence attributes that are also embodied in the products. Brand names, better service, longer warranties, more convenient locations, and so on will be used to differentiate the products, but these attributes are, by definition, not the major ones considered in the consumer’s purchase decision in the case of search goods. Rather, they are minor but nonetheless significant considerations in the purchase decision. Typically, however, the opportunities for differentiating search goods are relatively limited or ineffective, since consumers’ attention is directed mainly to the search attributes of the products.
1 hus search products will tend to be clustered closely together in attribute space, with relatively little product differentiation across competing brands.
In Chapter 9 we introduced the term “symmetric” differentiation to describe product differentiation when the firms’ market shares are equal at equal prices. Essentially, each product is different, but so too are consumers’ preferences. Some prod-
See Philip Nelson, “Information and Consumer Behavior," Journal of Political Economy 78 (March-April 1978), pp. 311-29. ’
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ucts have an advantage in one or more attribute dimensions, appealing to some consumers, and other products are superior in other attribute dimensions, appealing to other consumers, such that each seller attracts an equal number of the available buyers at a given price.
To the extent that the market for a search product approaches symmetric differentiation, we should expect the firm to find advertising relatively ineffective in persuading consumers that its product is substantially different from those of its rivals, because consumers can readily evaluate the differences for the most part, and the firms have a profit incentive to keep the quality of their products competitive. In general, the responsiveness of demand to changes in advertising will be relatively low. In other words, the advertising elasticity of demand is relatively low for search products.
Price elasticity of demand, on the other hand, will be relatively high for search products, since consumers know exactly what they are getting and leap at the chance to buy the product at a “lower than normal” price. A price reduction will distinguish the firm’s product from rival products and will capture many consumers from rival sellers if rivals do not react to the price reduction by similarly reducing prices. In Chapter 10 we saw that promotional pricing will work particularly well with search products.
If rivals do not match price reductions, demand will be more elastic than if they do, and even if they do match price cuts, demand will be more elastic for search goods than for experience or credence goods. When rivals match price reductions, they tend to do so with a lag, since time passes before the price cut is discovered, before the decision to match the price cut is made, and before this information is communicated to potential buyers, such that the firm initiating the price adjustment benefits from a relatively elastic demand response initially that may make the price cut worthwhile. Given the profit incentive to reduce prices, the general price level is likely to tumble downward to a level close to the firms’ unit cost. We saw in Chapter 10 that the more price elastic demand is, the lower the profit-maximizing markup rate will be. Thus we expect to see relatively low markups (price-cost margins) in the market for search goods.
In such a market, where persuasive advertising is relatively ineffective and price competition keeps prices down near to the level of the firms’ unit cost, competitive advantage (superior profitability) can be obtained only by having a lower cost structure than the other firms. If the firm has a cost advantage, it need not fear rivals cutting their prices below its costs, because its costs are lower than rivals’ costs, and rivals will not wish to make a loss on any product (temporary “loss leader” situations aside). Thus a cost-leadership strategy is likely to be the best strategy for search products, other things being equal.