Differentiation, Niche and Cost Leadership Strategies: A Hotelling Based Analysis

Costs are an important determinant of prices charged by firms. The primary purpose of this paper is to study the impact of costs associated with differentiation and niche strategies on firm’s positioning and pricing decisions in a horizontally differentiated market. We analyze both sequential and simultaneous entry cases. In the sequential case, the cost of differentiation is an additional cost incurred by the second entrant and it depends on the degree of differentiation between itself and the first mover. The cost of following a niche strategy is a market level cost affecting both firms whereby firms incur a positive or negative cost if they want to make a niche product. Our analysis provide some surprising results, explains some conflicting empirical observations documented in previous research, and may also be useful for further empirical research in this area by providing sharper predictions about the impact of various types of costs on market outcomes. For example, we find that under some circumstances the cost disadvantaged firm can enjoy higher price-cost margins compared to the cost leader thereby suggesting that higher costs are a blessing in disguise. We also show analytically that a firm following differentiated or niche strategies charges a higher price than the cost leader if the cost of differentiated or niche strategy is sufficiently high and vice versa.