MARKET SEGMENTATION, PRODUCT DIFFERENTIATION, AND

MARKETING STRATEGY1

INTRODUCTION
Markets have been segmented and products and services differentiated for as long as suppliers have
differed in their methods of competing for trade. The major advance in recent times has been that
market researchers are using economic and behavioral theories and sophisticated analytical
techniques in their search for better ways of identifying market segments and product differentiation
opportunities.

The first section presents some of the theories and perspectives of market segmentation and product
differentiation that have been developed by economists and marketers. A set of definitions has been
included in an attempt to lessen the current confusion in terminology.

HISTORICAL PERSPECTIVES
The concepts of product differentiation and market segmentation have long been discussed in the
literature. Also generally overlooked by both marketers and economists has been what Chamberlin
(1965) had to say about market segmentation and product differentiation in his theory of
monopolistic competition, first published in 1933. Product differentiation was defined simply as
distinguishing the goods or services of one seller from those of another on any basis that is
important to the buyer and leads to a preference. Chamberlin recognised the importance of both
consumer perceptions and nonphysical product characteristics in observing that the basis of
differentiation could be real or imagined, arising from distinct product, packaging, or distribution
differences, or the prestige value of a trademark and the trade name.

Porter (1976) also viewed product differentiation as depending on both physical product
characteristics and other elements of the marketing mix. Like Chamberlin, he recognized that
product differentiation could be based on perceived as well as actual physical and nonphysical
product differences. Smith (1956) described product differentiation as an attempt to alter the shape
of the price-quantity demand and promotion. The creation of imaginary differences when no real
differences exist through such devices as product names and skillful advertising has been labeled
“pseudo-differentiation” by Lancaster (1979).

1
Prepared by Prof. L.K. Vaswani from various sources for classroom discussion only.
1
In addition to the inconsistent treatment of the term “product differentiation,” the literature reflects a
similar confusion or lack of precision in use of the term “market segmentation.” This term often is
used to refer to recognition of the existence of multiple demand functions and development of a
marketing plan to match one or more of these demand functions. According to this use of the term,
the segments with different demand functions are assumed to exist, and the objectives are to
identify and cater to these groups rather than to alter or enhance differences in their demand
functions. Market segmentation thus is seen as a way of viewing the market rather than defined as a
management strategy. The purpose of such an analysis is to provide a foundation for market
segmentation strategy.

DEFINITIONS
Under ideal conditions, the total market would consist of subsets or segments whose within-group
differences in individual demand functions would be relatively small in comparison with the
between-group differences. Different firms’ conclusions about the number and properties of market
segments therefore will vary with their conceptual and analytic approaches to segment
identification. We therefore define “market segmentation” as a state of demand heterogeneity such
that the total market demand can be disaggregated into segments with distinct demand functions.
Each firm’s definition, framing, and characterization of this demand heterogeneity will likely be
unique and form the basis of the firm’s marketing strategy. Consequently the accuracy of the firm’s
perception of market segmentation often is a critical determinant of competitive advantage.

Product differentiation also is defined as a marketplace condition. The prevalent condition is one
in which all products are not perceived as equal on each of the product characteristics, including
price. We term this condition a state of “product differentiation.”

The preceding definitions lead directly to management strategies that may be pursued. One is
demand function modification, the alteration of the functional relationship between perceived
product characteristics and market or segment demand. In addition, the firm may attempt to change
the consumer's ideal point on an attribute to a location nearer to that of its offering. The marketing
literature generally has viewed the alteration of consumer values and tastes entailed in these
strategies as more difficult to achieve than a change in perceptions of product characteristics.

2
"Market segmentation strategy" usually refers to use of information about market segments to
design a program(s) to appeal to a specific existing segment(s). The firm also may wish to consider
developing the condition of market segmentation through demand function modification. Under
this strategy, which we term "segment development strategy," the firm would attempt to cause the
development of a homogeneous group of individual consumer demand functions that differ from the
demand functions of the remainder of consumers in the marketplace.

The term "product differentiation" also may be used to describe a management strategy. It is best
viewed as creation of a state of product differentiation by offering a product that is perceived to
differ from the competing products on at least one element of the vector of physical and
nonphysical product characteristics. As this strategy may be pursued through product design in
specification of actual product characteristics and/or through advertising directed at establishing
perceptions of both physical and non-physical product characteristics.

STRATEGIC OPTIONS
The strategic options available to a competitor can be illustrated best 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 primary importance. Brand locations in this two-dimensional
space are representations of consumers’ perceptions of the offerings and these perceptions are
assumed to be homogeneous for this discussion.
° Consumers’ tastes and values are represented through location of their ideal points.
° Another simplifying assumption is that the metric on the two axes is homogeneous for all
consumers.
° Finally, we assume that the maps accurately represent the true marketplace conditions.

Competitors who fail to understand thoroughly the true market configuration may fail to identify the
alternative strategies or may pursue other strategies that are inappropriate for the market.

Product Differentiation
Figure 1 illustrates a competitive situation in which there is neither product differentiation nor
market segmentation. The three competitive offerings, a b, and c, share the same approximate
position, and ideal points are distributed uniformly throughout the space. With this configuration,
each of the brands will achieve an approximately one third of the total market. A competitor in this
3
situation may achieve a competitive advantage through a strategy of product differentiation. If, for
example, brand 'a' were to move to position in Figure 1 by differentiation axis Y, it would increase
its market share because it would be closer 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.

Note that Figure 1 contains no natural groupings of ideal points, and the product differentiation
strategy therefore is not accompanied by either of the strategies of market segmentation or segment
development.

Figure 1: Product Differentiation in a Uniformly

Distributed Preference Space

a'

x
a b c

Shaded area represents uniform distribution of consumer ideal points

Figure 2 represents another set of competitive conditions in which a strategy of targeted product
differentiation would be very advantageous. In this diagram the distribution of consumer ideal
points is not uniform, but unimodal (e.g., bivariate normal). Each of the brands could increase sales
by moving closer to I, the centroid of the ideal point distribution. This situation would be likely to
lead to active competition among the three brands, with each attempting to be perceived as being
closer to I than its competitors. Ironically, if all three brands were successful in moving to point I,
the resulting configuration would reflect no product differentiation and the three brands would share
the market as before. Such interbrand competition would result in a closer matching of consumer

4
wants and product offerings and the possibility, at least initially, of an increase in either the general
price level or total market demand or both. Product differentiation definitions that are confined to

non-physical product characteristics may cause the marketer to fail to respond on all relevant
dimensions in attempting to pursue the strategy depicted in Figure 2.

Figure 2: Product Differentiation in a Unimodal

Preference Space

I1
.a

x
a b c

Figure 3: Product Differentiation in a Multimodal

Preference Space

I1 I3
.a '
.C ' x

x
a b c

.b'
I2
5
Segment-Based Product Differentiation
Figure 3 shows the existence of three market segments whose sizes are represented by the area of
the corresponding circles. This is a third condition under which product differentiation may be
beneficial. But in this case it is coupled with a market segmentation strategy. Because the three
brands are initially undifferentiated, any of them could increase sales by moving closer to I 1, the
centroid of the largest segment (e.g., a move to a’). This is an example of a segment-based product
differentiation strategy. Note that if one brand were to make such a move, the choice of the
remaining brands between moving toward I2 or I3 and moving toward I1 (and sharing sales of
segment 1) would depend on the relative sizes of the market segments and the costs of the
alternative moves. If brand 'a' were to achieve product differentiation in the direction of I 1, it could
increase its price to adjust for its more accurately meeting the needs of segment1.

The condition in Figure 3 corresponds to Chamberlin’s (1965) observation that where the possibility
of differentiation exists, sales depend on the skill with which the good is distinguished from others
and made to appeal to a specific group of buyers.

Demand Modification Strategy

A situation in which a demand modification strategy may be beneficial is shown in Figure 4. In this
diagram, product differentiation already exists, perhaps through the unique product characteristics
or brand images of the three firms. Because brand 'a' is perceived as having a higher level of
characteristic Y, it could increase sales by creating a segment centered at position a. Note that this
demand modification would not be effective without product differentiation as an existing state or
as a concurrent strategy. In the latter case, the brand would attempt simultaneously to move to
position 'a' and to cause ideal points of a group of consumers to converge at that position.

Product differentiation definitions that recognise only one demand function would not lead to the
strategy depicted in Figure 4, and those that constrain it to nonphysical attributes would lead to
failure to consider all relevant dimensions. This sort of combination of product differentiation and
demand modification centered on a so-called "unnecessary feature" often has been the target of
social welfare economists.

6
A final strategic option is the combination of market segmentation strategy and demand function
modification, as shown in Figure 5. In this situation, both product differentiation and market

Figure 4 : Demand Function Modification of a Uniformly

Distributed Preference Space

a

x
 b
c

Figure 5: Demand Function Modification of a Market Segment

.a

I2
b I1

I3

c
x
7
segmentation exist. Initially one would expect brand ‘a’ to have the lower market share because it
is sharing segment 1 sales with brands b and c, which also have separate, proximate segments.
Instead of moving the perceived location of brand a to I1, the firm could choose to emphasise
attribute Y to members of segment 1 in an attempt to move I 1 to a. This approach is 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 "market segmentation strategy." Market segmentation strategy
discussions that ignore the possibility of demand function modification, as well as product
differentiation definitions that recognise only one demand function, would clearly fail to identify
this strategic option.

Conclusion
The preceding discussion leads to a set of summary statements about possible strategic options.
° First, we can see that the preferred strategic option is determined primarily by the existing
market conditions.
° Second, we can see that a strategy of product differentiation does not require the existence of
market segments (Figure 1 and 2), but may be used in conjunction with market segmentation
strategy when segments are perceived to exist (Figure 3).
° Third, a strategy of segment development is feasible only when product differentiation either
already exists or is an accompanying strategy.

Within this framework, product differentiation and market segmentation are clearly not alternative
management strategies. A product differentiation strategy can be pursued with or without a market
segmentation strategy, but a market segmentation strategy can be pursued only when product
differentiation already exists or when accompanied by a complementary product differentiation
strategy. It shows that Smith’s (1956) discussion of market segmentation as alteration of the
product to match more clearly the needs of a segment actually corresponds to a combination of
product differentiation and market segmentation, as shown in Figure 3.

Though market segmentation and product differentiation are key marketing concepts, there has been
little discussion about their underlying theory. There is evidence that these concepts have been
confused with each other in the literature. Because they have very different implications for

8
strategy, it seems important for both managers and academics to share a common, accepted
understanding of the theoretical and applied meaning of these concepts.
Wellsprings of growth
20 Sep, 2007, 0017 hrs IST,V N Bhattacharya,

Most companies practise segmentation in very rudimentary ways, and not very effectively.
Companies tend to favour segmentation by size and industry type. It tells them something about
how customers use what they buy. The buyer’s size may indicate prospective volume, economic
buy size, and the size of wallet.

But these methods don’t provide insights into how customers behave, what impels them to buy this
product or that, and how they reach those decisions. Simplistic methods give the false impression
that one is addressing large markets. In the process, managers overlook opportunities that lurk in
segments within.

The way people, and firms, think and feel influences their buying behaviour. Their circumstances,
strategies and ambitions for the future — and they change with time — determine the choice of
brands they buy, vendors they keep and how they decide. Growth and profit opportunities are
hidden behind these higher order variables of segmentation.

Nike has brilliantly exploited this fundamental principle. In each broad segment of sport, athletic
shoes, equipment and apparel, they have targeted customers who desire value or identify with high
performance. They design products for high performance and position them for the serious athlete.
They signal it through brand ambassadors who are world leaders in their fields: John McEnroe,
Michael Jordan, Tiger Woods and Roger Federer, among others. They establish leadership in one
sport before moving to a new product category within, or another sport. Nike has used smart
segmentation as a repeatable source of growth.

Sophisticated segmentation is not always easy in business markets. Unlike individual consumers,
purchase decisions are made and influenced by a number of people, some of whom are invisible or
unavailable. Their perceptions shape the customer’s behaviour but remain hard to map. An
unknown mix of rationality and subjectivity conditions the way business customers reach decisions.
Circumstances also determine how customers feel about their needs. In hard times, a firm may wish
to buy economically; in good times they may be inclined to the long-term view.

Praxair India has used circumstantial need as a useful variable for segmentation. They pioneered the
use of argon for gas metal arc welding (GMAW) in India. Traditionally carbon dioxide has been
used to envelop the area being welded, from oxidation. Argon-based shielding gases facilitate
superior weld quality and faster production. The challenge was to sell argon-CO2 mixture at prices
three to four times that of CO2.

Praxair sliced the GMAW market further using these additional parameters: firms or fabricators that
sell to quality conscious customers and they, or their customers, compete with global majors; those
to whom welding is a critical process that contributes to functionality, safety and aesthetics of end
products; where cost of gas for welding is small compared to the selling price of their products;
businesses that wish to grow and can easily sell increased production.

9
Praxair reasoned that such companies were likely to consider a superior alternative. They began by
targeting companies like Bajaj Auto, Hero Honda and L&T. These firms knew Argon was better but
were using CO2. Their key value driver was the ability to increase production. They turned out to
be early adopters. In turn they encouraged, even persuaded, their ancillaries to adopt Argon.

Praxair’s annual revenue from the segment has been rising at over 40% CAGR since 2000. In 2005
it topped Rs 120 million. Powered by demand from 150 customers, business is expected to double
to Rs 250 million in 2007. By astutely separating customers who were keen and able to grow in
competitive markets, they created a profitable revenue stream.

There are many reasons why the practice of segmentation continues to be rudimentary. Managers
cast in the objective rationality mould abhor absence of hard data. Customer behaviour is nebulous,
messy and notoriously hard to quantify.

Reluctance to base decisions on insight is exacerbated by an unwillingness to ask customers,

observe their behaviour and detect patterns. Managers don’t do enough to mine collective insight
within the company. What is available, remains buried.

The more insidious reason, however, is that many companies are blinded by the ambition to grow.
Size rather than shareholder value achieves primacy. A large market appears more attractive than a
smaller one. When growth at any cost becomes the driver, it makes sense to aggregate segments and
prepare offerings that have a broad appeal. Not surprisingly, products are built with least common
denominator features and priced to suit all pockets. They become price warriors, belie the initial
promise, limp along or die expensive deaths.

In the year 2000 Windshield Experts (WE) took a bold step by opting to enter a non-existent market
in India: the business of repair and replacement of automotive glass. Vehicles that suffer damage to
glass but not the body have traditionally been repaired either by the distributor, or an authorised
service agency. They promise reliability, assurance of genuine parts, and usually take one or two
days to finish the job.

WE chose to target customers who value quick turnaround more, provided reasonable reliability
was assured. Those who are dependent on their vehicles for livelihood — people who are constantly
on the run, or ply their vehicles commercially — find compelling value in WE’s proposition to
repair or replace glass in a matter of hours rather than days.

WE sub-segmented the market for automotive glass replacement and targeted those who value
speed. From four outlets in year 2000 and 37 in 2006, they will be 60 strong by end 2007. They plan
to cross a hundred in 2008-09. Revenue has risen from Rs 7 million in 2000 to 250 million in 2006-
07 and continues to grow.

Praxair and WE sought opportunities in slices rather than larger market segments. Praxair gained a
new stream of profitable revenue that has grown steadily for ten years. WE has created a whole new
business. By targeting narrow segments both have managed to create enduring competitive
advantage and uncovered practically inexhaustible opportunities for growth and profits. Nike will
testify it is possible.

(The author is a management consultant)

10
Rewind 2016: Positioning and differentiation: The Bajaj way
The motorcycle major's MD Rajiv Bajaj explains the strategy behind the 'Invincible' new offering, V
“I want to share with you our strategic perspective, based on which we set about conceiving and developing
this product (Bajaj V). As you know well, in about half the motorcycle market, comprising the entry and the
sports segments, we are already, by far the leader. But the middle of the market, which is about… the other
half of the market, has been elusive as far as we are concerned. Typically, commuters buy 100 or 125 cc
motorcycles in that space, about 500,000 motorcycles every month
We said to ourselves that we would keep things simple and go for this market with two things. One, of
course, is a good product. And secondly, a good story – or a good position for the product.
Typically, manufacturers tend to approach this with one or two thought processes or strategies. Most people
approach such a task, with what I like to call the ‘strategy of familiarity’. They see something out there that
is doing well, and they say to themselves, that if I also were to make something similar, I would succeed, I
would get a reasonable share of the market – our own belief, at Bajaj, is that this never works. He who is first
to market continues to lead that segment or that category. And all those who seek to ape him by making me-
too products only serve to endorse the leader. So instead of the strategy of familiarity, which seems very
comfortable to start out with, but then fizzles out and goes nowhere, we as a company believes in the strategy
of differentiation.
And quite simply that means, not just giving customers what they want. That is obvious. I don’t think we
need marketing departments or agencies to tell us what they want – any fool knows that. What is important is
to be able to give customers what they want, and what competition does not – or cannot, easily.
Where should differentiation start?
When talking specifically of the auto industry, especially two-wheelers, and in this case motorcycles, a lot of
the time, differentiation seems to start with…. brand ambassadors, for example. As if people are walking into
a showroom to take a cricketer or an actress home. It (differentiation) seems  to start with the headlamp, with
whether the tyre has a tube or not, it seems to start with how long or short the seat is, some notion of comfort,
some notion of some aesthetic detail somewhere.  
But I have come to realise, after 25 years in this business, that there is a lot to be said for that American
saying in the context of motorcycles, that ‘There is no replacement for displacement’. For us therefore,
differentiation starts with the displacement – the size of the engine, what we call cubic capacity or cc of the
engine. Once one articulates that a bike is of 100 cc, 125 cc, 200 cc or a litre, the consumer immediately
plays in his mind a movie, of all that he can and cannot expect from that motorcycle. Just imagine, if we
were to present to you a 100 cc bike, with the metal of (INS) Vikrant…. It just wouldnt stick.  
We have come to believe that there is no replacement for displacement. It worked very well for us in 2001,
which was a turning point for Bajaj as it moved from scooters to motorcycles. 

In 2001, we launched the Pulsar. With that launch, if I may say so, we changed the sports biking or the
premium motorcycles segment on its head. We dominated it from day one. We do so even now. What was
the reason for the success of the Pulsar? The CBZ was there in the market before us. The TVS Fiero was
there in the market before us. What made Pulsar successful, was that it was, first and foremost, differentiated
by displacement. Very few people have actually realised, that the Pulsar was launched as a 180 cc bike. Of

11
course, it was also available as a 150 cc for those who felt more comfortable with that. But in terms of its
positioning, in terms of its communication... if you remember that advertisement which said, ‘It’s a boy’, and
somebody went thundering down the Mumbai-Pune Expressway on the Pulsar. That was a 180 cc Pulsar.
The reason it was able to make a mark for itself, was that it was not another 150 cc bike in the market place,
like the CBZ or the Fiero. It was a notch above as a 180 cc that offered much more performance.  
We’ve come to realise that these two aspects we must apply to the task – the left-brained and the right-
brained – are both equally important. From the left brain comes the desire to create a new, differentiated
product. And from the right brain must come the ability to create a new position. The product in itself will
sell, only if there is a marketing position based on which one can sell it.

Testing the hypothesis, again  

Looking back, I am very certain, that if the Pulsar had been launched as a 150 cc motorcycle, only, it would
still have been a great motorcycle, but one without the position that was at the time articulated as ‘Definitely
male’. Customers would have walked into the showroom and said, ‘What is Definitely male about your
motorcycle? There is a CBZ, there is a Fiero. You are just another male, you are not Definitely male.’     But
when we had a 180 cc motorcycle standing there, they could not dismiss us like that. They had to grant it to
us that we had created a different position.  Creating a different position, to us, is what is marketing. And
sales without marketing, is like a ship on dry land. It may have all the potential to go far and wide, but it is
never going to go anywhere.  
In 2016, fifteen years after what we did with the Pulsar, we are testing the same hypothesis again. Most
people  would intuitively think, ‘These guys have lost it…. Commuters just want a mileage motorcycle,
something that gives them good mileage, costs about 50,000 rupees… Will last forever. Bajaj is out of its
mind coming out with a 150 cc commuter motorcycle, a displacement that is usually associated with sports
biking.’  
Our thought process is quite the opposite: How are you going to crack Hero’s impenetrable hold on this
market? With the 50th 100 cc bike? The 30th 110 cc bike (no matter how many valves and spark plugs it
might have in it)? Or the 25th 125 cc bike in the market place? We don’t think that is going to cut it. As
Einstein said in a different context (but I think it very much applies), ‘A problem is never solved at the level
at which it is created’. If competition creates a problem for us at the 100 cc level, we must have a 125 cc
solution. If it’s at a 125 cc level already, we need a 150 cc solution. To our counter-intuitive way of thinking,
this was very obvious – we needed to create a new 150 cc motorcycle, with a distinct and differentiated
positioning.   Connecting the two dots   I am very pleased and proud to present one of our engineers from our
R&D, Mushtaq, who is part of a team that created this product.
Beyond stating that the V would be a bike that would be ‘Invincible’ in daily commuting, we really didn’t
have the skill to articulate it in a charming, catchy way, and put that ‘X’ factor into it, which would amplify it
so many times in the minds of people. And that came, from an equally ‘junior person’, Kevin (from Leo
Burnett, our ad agency). I was in office and my marketing team came up to me, and said, ‘Boss this is a
video that I think you should see’. I would have had to be stupid not to see the potential in that.  
It struck me that all I needed to do was connect these two dots – the design that Mushtaq has created, and the
position that Kevin has articulated – and some magic is going to happen.”    
(Edited excerpts from Bajaj Auto MD Rajiv Bajaj's address at an event to announce the Bajaj V on 1
February 2016, which has infused in it metal from India's first aircraft carrier warship and celebrated war
hero, the INS Vikrant. This article was first published on 8 February 2016.)

12
Read more at: http://www.campaignindia.in/article/rewind-2016-positioning-and-differentiation-the-bajaj-
way/432667

13