Why is this not true in the real world Consumers are heterogeneous not just

Why is this not true in the real world consumers are

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Why is this not true in the real world? Consumers are heterogeneous (not just firms) Coke creates more value for some consumers; Pepsi creates more value for others Some car customers place a high value on quality and get a bigger surplus from a high-priced car; others place a lower value on quality and prefer a low-priced car This means many firms can have positive added value and earn profits Understanding the structure of consumer heterogeneity is key to carving out a successful strategy
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28 Vertical Differentiation Vertical differentiation refers to dimensions where all consumers agree “more is better” freshness of food in a restaurant miles-per gallon of a car memory & speed in a computer first / business / economy class on a plane If consumers differ in their valuation of quality (or their sensitivity to price), some firms will offer high-price & high-quality goods while others will offer low-price & low-quality goods
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29 Vertical Differentiation: Example Suppose Apple and Dell both make one laptop model: Dell Inspiron: has 1.5GHzprocessor, and costs $900 Apple MacBook Pro: has 2.5GHzproc., costs $1700Suppose there are two kinds of consumers Powerusers have U = 1000 + 1000*SPEED - PNormalusers have U = 500 + 500*SPEED – Who will buy which computer? What would a more sophisticated model of vertical differentiation include? P
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Apple’s Product Matrix 30
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31 Horizontal Differentiation Horizontal differentiation refers to dimensions where consumers disagree about which is better Food: meat vs. fish vs. tofu Car: SUV vs. sedan vs. sportscar OS: Windows vs. Mac vs. Linux Hotel: Loop vs. Mag Mile vs. Lincoln Park Markets with horizontal differentiation lead firms to carve out different niches targeting specific customers Locating “far away” from competitors softens price competition and boosts profits Useful question: are there any customers who like my product better than anyone else’s
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32 Horizontal Differentiation: Example An obvious example of horizontal differentiation is geography The classic model of this is due to Hotelling Suppose two shops locate at opposite ends of a street Consumers are evenly distributed along the street and pay some transportation cost t per unit travelled Firms set prices simultaneously (as in Bertrand) Store 1 Store 2 consumer
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33 Horizontal Differentiation: Example Note: Hotelling line is just a metaphor for any characteristic that can be ordered Hotels: very classic to very modern Drinks: very bitter to very sweet Laptops: light / small screen to heavy / large screen Politicians: far left to far right Store 1 Store 2 consumer
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34 Product Differentiation and Positioning In making positioning decisions, firms must trade off two potentially conflicting incentives Consider what happens if store 1 moves closer to store 2 on the Hotelling line Store 1 captures more consumers (this is the direct effect) Store 1 faces stiffer price competition (this is the strategic effect). Demand becomes more elastic. Key to a good strategy: locate where there are lots of consumers and few competitors Store 1 Store 2
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35 From Added Value to Strategy Best way to increase profits is to increase added value —that is, drive a bigger wedge between benefits and costs How do we identify what strategic moves will do this?
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