The creation of real or imagined differences in essentially the same type of product by means of branding, packaging, advertising, quality variation, design variation, etc. It is most prevalent in consumer goods industries, e.g. washing powders, cosmetics, automobiles, cigarettes and alcoholic drinks. The purpose of product differentiation is to build up ‘consumer loyalty’ to one firm’s product or brand. This may permit it to raise price above undifferentiated versions of the same product so as to make greater profits. It may also ensure greater stability of sales, which facilitates production and sales planning. Some degree of product differentiation is quite likely to be in the consumer’s interests since there will generally be a range of tastes and incomes which are best served by a range of product qualities and designs. In the motor-car industry, for example, the range of models from expensive, high-quality, high-performance sports cars to lower priced, mass-produced saloons clearly meets a wide variety of tastes and incomes. Economists’ objections to product differentiation usually centre on cases where it involves wasteful expenditures on advertising, packaging and design changes. It may also result in too many brands, which prevents the realization of full economies of scale, and it creates barriers to entry of new firms and allows firms to make excessive profits.
Reference: The Penguin Dictionary of Economics, 3rd edt.