How Does Product Differentiation Affect Price Elasticity?

With product differentiation, you brand your company as a provider of a distinct product with features and benefits unmatched by competitors. Elasticity refers to the relative change in product demand when you change your price. A primary benefit of differentiation is that it can make your brands more inelastic -- meaning customers more easily tolerate price increases. The number of available substitutes for a given product has a direct impact on its price elasticity.

Whether you manufacture or resell products, you can operate with a differentiated or mass-marketed approach. With effective differentiation, you minimize the perception among consumers that your brand has many close substitutes. While differentiation may lead to a more selective target market relative to a more universal, mass-marketed product, it also increases your pricing flexibility given that customers recognize the value of your particular product attributes.

Differentiation and elasticity correlate in that the more distinct your product, the greater your ability to stretch on price. Highly elastic demand means that customers won't budge much on the price of your product. If you have a product viewed as very similar to competing products, customers won't accept significant increases in price. However, if you can develop and communicate clearly distinct benefits, customers who want those benefits will more easily tolerate price increases. This factor makes for more inelastic demand.

Effective product differentiation results from the synergy of two core factors -- product development and effective positioning in marketing. Making products that have patented or unmatched features or acquiring and adding value to such products is a starting point to differentiation. Customer perception is most critical, though. The way you position and market your brand as offering specific benefits to a targeted group of customers has a significant effect. The more distinct and beneficial customers view your brand, the more pricing power you have.

Selecting the right price point is integral to effective business marketing. When you successfully differentiate and build demand inelasticity, you also give yourself greater ability to charge higher prices and earn higher margins. Many small businesses operate with a niche differentiation strategy. This means that rather than challenging larger competitors directly, they attempt to appeal to a niche group of customers who desire specific benefits and are willing to pay top dollar. A small arts and crafts store might take this approach, for instance.