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Market
Product
Segmentation,
and
Differentiation,
Marketing Strategy
Despite the pervasive use of the terms "market segmentation" and "product differentiation," there has
been and continues to be considerable misunderstanding about their meaning and use. The authors
attempt to lessen the confusion by the use of traditional and contemporary economic theory and product
preference maps.
PeterR.Dickson
is Assistant
andJamesL.Ginter
Professor
is Professor,
Academic
of Marketing,
TheOhioStateUniversity.
Theauthors
Faculty
thethoughtful
comments
andcriticisms
on eargratefully
acknowledge
lierversionsof thearticleprovided
Fraser,
by BrianRatchford,
Cynthia
W.WayneTalarzyk,
AlanSawyer,FredSturdivant,
Barton
Weitz,and
JMreviewers.
anonymous
Journal of Marketing
Vol. 51 (April 1987), 1-10.
andMarketing
ProductDifferentiation,
Market
Strategy/ 1
Segmentation,
arises from the fact that various authorsdiscuss differentiationof the market,products, and strategy, and
the distinctionsare seldom made clear.
We attemptto clarify the currentmisunderstanding by precisely defining and contrastingmarketsegmentation,productdifferentiation,and demandfunction modification on both theoretical and practical
dimensions. In the first section we present some of
the theories and perspectivesof marketsegmentation
and productdifferentiationthat have been developed
by economists and marketers.We then offer a set of
definitionsin an attemptto lessen the currentconfusion in terminology.Finally, we use preferencespace
mappingand practicalexamples to illustrate the importantdifferences and relationshipsbetween product
differentiationand demand modification, given various states of demandheterogeneity.
HistoricalPerspectives
The concepts of product differentiationand market
segmentationhave long been discussed in the literature. One of the pioneers of marketingthought(Shaw
1912) describedthe strategyof productdifferentiation
as meeting human wants more accurately than the
competition.The result is a "buildupof demand"for
the producer'sproductand a potentialfor a price level
higher than that of the existing stock commodity. In
discussing the need to treat each distinct geographic
region as a separatedistributionproblem, Shaw emphasizedas equally importantthe recognition of economic and social market"contours"and the need also
to treatthese as separatemarketingproblems. Besides
specifically recommending separate contour or segment analysis, he pointed out that the law of diminishing returnsimposes a limit on the practical value
to the companyof cateringto these differentmarkets.
Also generally overlooked by both marketersand
economists has been what Chamberlin(1965) had to
say about marketsegmentationand productdifferentiationin his theory of monopolisticcompetition, first
published in 1933. Product differentiation was defined simply as distinguishingthe goods or services
of one seller from those of anotheron any basis that
is importantto the buyer and leads to a preference.
Chamberlinrecognized the importanceof both consumerperceptionsand nonphysicalproductcharacteristics in observingthatthe basis of differentiationcould
be real or imagined, arising from distinct product,
packaging,or distributiondifferences, or the prestige
value of a trademarkand tradename (e.g., Coca-Cola,
Kodak, or Calvin Klein). Chamberlinalso recognized
that differencesin buyer preferencesresult in a set of
differentdemandcurves. The heterogeneityin the offering, production,prices, and profits observed in the
marketwas not, in his opinion, the result of imperfect
knowledge or other market "frictions,"but a reflection of the unsuccessful and successful attempts of
manufacturersto adapttheirproductsto the needs and
tastes of differentbuyers.2In his first edition, Chamberlinstatedthat there seemed to be no particularreason why the demand curve would change when a
productis differentiated.However, by his third edition, Chamberlinhad recognizedthatthe demandcurve
would move to the right and therefore become less
price elastic when the differentiatedproductmore exactly satisfied consumerneeds.
Porter(1976) also viewed product differentiation
as dependingon both physical productcharacteristics
and otherelements of the marketingmix. Like Chamberlin, he recognized that productdifferentiationcan
be based on perceived as well as actual physical and
nonphysicalproductdifferences. Porter also adhered
to the traditionaloperationaldefinitionof productdifferentiationas the degreeof cross-priceinelasticitywith
respect to competing brands. In a demand equation
this cross-inelasticity is represented by a demand
function for the firm's offering that is relatively unaffectedby changesin the prices of competingbrands.
Samuelson (1976) discussed what we term "demand function modification" when he asserted that
suppliers "deliberately fragment" industry demand
curves into smaller segments through "contrived"
productdifferentiation.His leadingeconomicstext thus
takes the position that the supplieris the majorcause
of segmented market demand. Samuelson acknowledged that product differentiationcan be a genuine
response to differing consumer needs, but he clearly
believed that most product differentiationis "artificial." He also repeated Galbraith's (1967) assertion
thatthis is achievedby advertisingthat "distorts"consumer demand.
Inhis classic article,Smith(1956) expresseda view
of productdifferentiationsimilarto Samuelson'sposition. He described product differentiationas an attempt to alter the shape of the price-quantitydemand
curve facing the individualsupplierusing advertising
and promotion.If Smith was referringto alterationof
the consumer's demand function when he described
productdifferentiationas being "concernedwith the
bending of demand to the will of supply," this descriptionclearly differs from the view of Chamberlin
and Porter and fits what we subsequentlyterm "demandfunction modification."If, however, Smith actually was referringto alterationof the perceived vechis argumentis consistent
tor of productcharacteristics,
with those of Chamberlinand Porterwith the excep-
2 / Journalof Marketing,
April1987
Definitions
The following definitional frameworkis offered as a
basis for explaining and comparingthe various uses
of the terms "marketsegmentation"and "productdifferentiation" in the literature. This framework is
foundedin both the currenttheoreticaleconomic work
of Rosen (1974) and Lancaster(1979) and the more
traditionaleconomic theory describedby Chamberlin
(1965). The definitions are stated in Table 1.
The concepts of marketsegmentation,productdifferentiation,and demandfunctionmodificationcan be
defined and distinguished through reference to the
representationof marketdemand as
andMarketing
ProductDifferentiation,
MarketSegmentation,
Strategy/ 3
TABLE 1
Definitions
Construct
Market
segmentation
Product
differentiation
Product
differentiation
strategy
Definition
Heterogeneity in
demand functions
exists such that
market demand can
be disaggregated
into segments with
distinct demand
functions (Fi's)
A product offering is
perceived by the
consumer to differ
from its
competition on any
physical or
nonphysical
product
characteristic
including price
Alteration of
perceptions so as
to result in a state
of product
differentiation
Demand function
modification
Alteration of the
functional
relationship
between perceived
product
characteristics and
demand, i.e.,
changing F or Fi
Segment
development
strategy
Alteration of demand
functions of a
subset of
consumers such
that they will
become similar and
constitute a unique
market segment
Comments
Q = F (p,xl, ... xn)
=
Qi
Examples
The automobile market
The soap market
The camera market
This demand function is consistent with the multiattribute model commonly used in the marketing literature. It is also similar to the hedonic economic model
of demand with the exception that economists usually
separate price from the vector of product characteristics. It postulates that the demand, Q, for a particular product offered by an individual supplier is a
function of the price, p, and the product characteris-
tics of that offering, xl, ..., xn. These product characteristics include both physical product attributes and
nonphysical attributes, which may reflect dimensions
of image and product performance. The nature of the
functional relationship, F, will depend on the consumers' tastes, competitive product offerings, and other
marketplace factors such as disposable personal income.
We should note that the traditional economic concept of the market demand curve,
4 / Journalof Marketing,
April1987
Q = FxI
..... xn(P),
(2)
does not coincide perfectly with the form of the demand model in equation 1. In this traditionaleconomic model, demandis a function of price, given a
specified set of fixed productcharacteristics,and the
demand function will shift such that quantity demandedis greaterfor each price if the productcharacteristicsare changedto matchmore closely the consumerideal points.
There appearsto be some uncertaintyin the economics literatureaboutwhetherthe productcharacteristics in equations 1 and 2 are objective or subjective. Underthe commoneconomics assumptionof full
consumer information, there is no difference. The
marketingliterature,in contrast,recognizes that most
consumers base decisions on their perceptions of real-
selves shouldbe the theoreticalbasis for segment definition. Other bases for identifying or defining segments will be useful only to the extent that they
correspondempiricallyto these demandfunctionsand
lead to identificationof the true marketsegments.
Under ideal conditions, the total market would
consist of subsets or segments whose within-group
differences in individual demand functions (or ideal
points) would be relatively small in comparisonwith
the between-groupdifferences. Unfortunately, however, individualdemandfunctionsare not directlyobservableand segment distinctionsare usually blurred.
Different firms' conclusions about the number and
propertiesof marketsegmentsthereforewill vary with
their conceptual and analytic approachesto segment
identification.As a result, competingfirms may have
differentperceptionsof the marketsegment structure
of a marketthat exhibits demand heterogeneity. Because these perceptions of segments may provide a
basis for marketingstrategy, they may be one determinantof competitiveperformance.We thereforedefine "marketsegmentation"as a state of demandheterogeneity such that the total marketdemand can be
disaggregated into segments with distinct demand
functions.4Each firm's definition, framing, and characterizationof this demand heterogeneitywill likely
be unique and form the basis of the firm's marketing
strategy.Consequentlythe accuracyof the firm's perception of marketsegmentationoften is a critical determinantof competitive advantage.
Product differentiationalso is defined as a marketplace condition. If the productclass were a commodity, all alternativeswould be equal and perceived
to be equal on all elements of the vector of price and
both physical and nonphysicalproductcharacteristics.
The prevalentcondition is one in which all products
arenot perceivedas equal on each of the productcharacteristics, including price. We term this condition a
state of "productdifferentiation."
The preceding definitions lead directly to management strategies that may be pursued. One is demand function modification, the alteration of the
functional relationship, F or Fi, between perceived
product characteristicsand market or segment demand. For example, a firm may attempt to increase
the importancecustomers associate with a product
attributeon which it has a competitiveadvantage(e.g.,
AT&T emphasizing the value of personal telephone
services, BMW promotingadvancedengineeringand
andMarketing
ProductDifferentiation,
MarketSegmentation,
Strategy/ 5
metric on the two axes is homogeneous for all consumers. Finally, we assume that the maps accurately
representthe true marketplaceconditions. Competitors who fail to understandthoroughlythe truemarket
configurationmay fail to identify the alternativestrategies we discuss or may pursue other strategies that
are inappropriatefor the market.
Product Differentiation
Figure 1 illustratesa competitive situation in which
thereis neitherproductdifferentiationnor marketsegmentation.The three competitive offerings, a, b, and
c, sharethe same approximateposition,andideal points
are distributeduniformly throughoutthe space. With
this configuration,each of the brandswill achieve approximatelyone thirdof the total market. A competitor in this situation may achieve a competitive advantagethrougha strategyof productdifferentiation.
If, for example, branda were to move to position a'
in Figure 1 by differentiationon axis Y, it would increase its marketshare because it would be closer to
the ideal points of nearly half the market. In this situation, any one brand can increase its sales by differentiation(to a small extent) in any direction from
its competitors.Though we do not addressthe potential dynamics that would result from competitive reaction, one could speculatethat brandsb and c might
also attemptto differentiatetheir offerings from position a' and from each other. The variouscompetitive
solutionsto this problem depend on the natureof the
marketboundaries(see Lancaster 1979). Definitions
of product differentiationthat assume a single homogeneous demand function or limit the firm's actions to nonphysicalproductcharacteristicswould not
lead to identificationof this strategicoption for brand
1
FIGURE
ProductDifferentiationin a Uniformly
DistributedPreferenceSpace
Strategic Options
The strategicoptions availableto a competitorcan be
illustratedbest through reference to a product preference map. For ease of illustration,we assume that
two product characteristics, which may be either
physical or nonphysical, are of primaryimportance.
Brandlocationsin this two-dimensionalspace are representationsof consumers' perceptions of the offerings and these perceptionsare assumed to be homogeneous for this discussion. Consumers' tastes and
values are representedthroughlocation of their ideal
points. Another simplifying assumption is that the
6 / Journal
of Marketing,
April1987
ideal points.
0.a'
V?-?
a b c
KI-_
be~x
3
FIGURE
Y
Product Differentiation in a Multimodal
Preference Space
Qa
abc~
x?CI
a bc
Fj
andMarketing
ProductDifferentiation,
MarketSegmentation,
Strategy/ 7
FIGURE4
Demand Function Modification of a Uniformly
Distributed Preference Space
"judged"to be manipulativeand/or wasteful competitive strategy. Demand modification also may result in segment developmentwhen an attemptat concentratingdemandin one area of the space results in
multimodalconcentrationsof demand throughoutthe
space.
A final strategicoption is the combinationof market segmentationstrategyand demandfunction modification, as shown in Figure 5. In this situation, both
productdifferentiationand marketsegmentationexist.
Initiallyone would expect branda to have the lowest
marketsharebecauseit is sharingsegment 1 sales with
brandsb and c, which also have separate, proximate
segments.Insteadof moving the perceivedlocation of
branda to Il, the firm could choose to emphasize attributeY to members of segment 1 in an attemptto
move Ii to a. This approachis clearly an example of
what we have termed "demand function modification" and, as it is directed at only one segment, we
would also label it "marketsegmentation strategy."
Marketsegmentationstrategydiscussions that ignore
the possibilityof demandfunctionmodification,as well
definitionsthatrecognizeonly
as productdifferentiation
one demand function, would clearly fail to identify
this strategicoption.
In reality, demand modification often is accompanied by product differentiationand vice versa. In
the winter of 1983, Campbell's Soup launched a demandfunctionmodificationcampaignpromotinggood
nutritionand the importanceof the nutritionalvalue
of food. At the same time, it attemptedto differentiate
the product by positioning hot soup as not only an
excellent winter food (the theme of previous cam-
8 / Journalof Marketing,
April1987
FIGURE5
Demand Function Modification of a Market
Segment
y
0eb
*c
Conclusion
The preceding discussion leads to a set of summary
statementsabout the availabilityof strategic options.
First, we can see that the preferredstrategicoption is
determinedprimarily by the existing market conditions. Second, we can see that a strategy of product
differentiationdoes not requirethe existence of market segments (Figures 1 and 2), but may be used in
conjunctionwith market segmentationstrategy when
segments are perceived to exist (Figure 3). Third, a
strategyof segmentdevelopmentis feasible only when
productdifferentiationeither already exists or is an
accompanyingstrategy.Withinthis framework,product differentiationand marketsegmentationare clearly
not alternativemanagementstrategies. A productdifferentiationstrategycan be pursuedwith or without a
marketsegmentationstrategy, but a market segmentation strategycan be pursuedonly when productdif-
andMarketing
ProductDiffereitiation,
Strategy/ 9
MarketSegmentation,
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April1987