Question
In any market structure, an appropriate once-off expenditure on product differentiation will guarantee the firm’s ability to maximize economic profit into the future. Discuss.
Answer
In short, no one off action, including differentiation, can guarantee a firm’s success, or that it will achieve maximum profits.
This is because differentiation is only one factor that plays a role in firm success, and as markets change over time any advantage offered by differentiation will surely be eroded.
A crucial point is that differentiation may not result in an advantage, simply being different from competitors does not guarantee sales. A product must satisfy the needs of consumers if it is to be successful in the market, without this no amount of differentiation will be beneficial.
Similarly, even a good product with differentiation may not be successful if it is not marketed correctly, for example if it gains no awareness among consumers. Thus companies need to ensure a full marketing plan is created for products which ensures that they have strengths throughout the marketing mix (4Ps/7Ps).
Profitability of a firm is determined by more than just differentiation, or even marketing as a whole. A firm with good marketing and products can still make a loss if costs are not suitably controlled.
Economic profit is a specific type of profit which takes into account opportunity cost, which is a consideration for the alternatives that could be undertaken.
The economic profit of a firm thus must look at the returns that are made through its activities in comparison to alternatives – for example selling a different product, or moving to a different industry. Differentiation of a product offers no guarantees on profitability or economic profit. Even if success is gained in that particular market, it may be the case that it is a market with low returns in general and the firm would be better off employing its capital in a different industry.
