Indifference curves to decide price and quality strategy

Imagine you were the Chief Executive Officer of Apple Computers before the launch of the iPad. Suppose you were trying to decide what price and features the new product should have. By using indifference curves discuss how you might choose price and quality to gain a benefit or a cost advantage to gain a competitive advantage and which of these strategies you think would have been the best strategy for the iPad.

Introduction

According to Porter (1985), competitive advantage is the advantage one firm has over its competitors gained by its ability to create and offer consumers greater value. It can be separated into two basic types and may take the form of lower prices compared to competitors for equivalent benefits, or by providing greater benefits and services that justifies higher prices.

With that in mind, this essay will, by using indifference curves discuss how as the CEO of Apple Computers, I might decide on which strategy to adopt in the launch of the iPad. It will examine the strategies of cost and benefit/differentiation advantage so as to gain a competitive advantage and finally conclude with a suggestion of the best strategy for the iPad.

Indifference curves

The indifference curve is a set of price-quality combinations that yields the same Consumer surplus (CS) to a consumer. Since price and quality are opposites of each other, the slope of the indifference curve between the price and quality will be an upward slopping curse as represented in Figure 1, demonstrating that the consumer will require a higher standard of quality for them to be willing to spend more money on a good in order to remain equally satisfied and vice versa. Moreover, the further to the right the firm’s indifference curve is from the industry’s indifference curve, the more value it is said to be creating for its customers.

Value stems from the sum of CS a firm is able to provide its consumers and the profit it makes after reducing the cost of producing the good (C) from the price (P) of the good. Further, CS is defined as the perceived benefit (B) customers receive from the good minus the cost associated with obtaining it. Since CS can be expressed in terms of B-P, firms will in theory be able to get more value by either increasing B or decreasing C, since value can be represent as B-C. However, firms can only be said to be creating value if B>C.

Additionally, superior value is derived from offering lower prices than competitors for equivalent benefits or by providing unique benefits that more than offset a high price (Porter, 1985). That is, the firm’s value created from B-C must be larger than the B-C of its rivals for them to gain a competitive advantage from superior value. Moreover, in the case of the iPad whereby competition in the technological industry is strong, a firm’s objective would be to provide consumers with a higher CS than its competitors and thus achieving a higher market share.

Cost advantage

Porter (1985) a firm has a cost advantage if its cumulative cost of performing all value activities is lower than competitors cost. Cost advantage leads to superior value if the firm provides an acceptable level of value to the buyer so that its cost advantage is not nullified by the need to charge a lower price than competitors.

The objective of firms adopting a strategy of cost leadership is to become the lowest-cost producer in the industry, through the efficient production and supply of goods and services at a lower cost than its competitors (Grant, 2005). The sources of cost advantage are varied and depend on the structure of the industry. They may include the pursuit of economies of scale, proprietary technology, innovations in productions and distribution and preferential access to raw materials.

By offering products with a lower C, and the same or perhaps lower B, firms with a cost advantage are able to create more value by having its B-C being greater than its competitors (Besanko, 2010). In the case of the iPad, cost advantage can be achieved with streamlined software, efficient marketing and a global scale over which to amortize the cost of research and development (Porter, 1985). As noted in Grant (2005), the critical scale advantages of large companies are seldom in production but rather in marketing and advertising. However, although advertising is a key indivisibility in gaining a cost advantage, scale economies are also important in other non-manufacturing operations such as purchasing, R&D and distribution.

Based on the above, we observe that Apple would be able to achieve a cost advantage with the iPad as it keeps the greatest possible control over their operating systems (IOS) used in iPhone, iPods, iPod Touch, iPad and with same usage concept, few devices and one manufacturer, allowing the company to streamline hardware, software and efficient marketing. This compared to the competition, where different manufacturers are involved with all kinds of phones in different shapes and sizes and different operating system and hence will not be able to maximize economies of scale unlike Apple.

Furthermore, Apple has a competitive advantage with its OS X as, by having its own operating system, Apple is able to quickly and efficiently redesign the same OS to be usable on multiple platforms. Apple is able to have a first-to-market advantage and that is leading to product awareness through the extensive media hype. Hence, Apple’s cost advantage can be illustrated using indifference curves in Figure 1 whereby the cost of producing the iPad, represented by point is lower than the cost position of its competitors in the same industry whereby their cost of production would be at point .

Benefit advantage

Differentiation advantage by a firm is achieved when it provides something unique compared to competitors that is valuable to buyers beyond simply offering a low price (Grant, 2005). It is a strategy that involves charging a premium price and giving customers clear reasons to prefer the product over other, less differentiated products (Tutor2u, 2010). A firm that creates a competitive advantage based on differentiation creates more value than its competitors by offering a product with higher B for the same, or perhaps higher, C. It can exploit a benefit advantage by setting a price that allows it to offer higher consumer surplus than its rivals, while also achieving a higher profit margin (Besanko, 2010). Moreover, firms are able to offset the cost of differentiation by expanding its market share so as to lower it cost by spreading it over large quantities utilizing scale economies.

A firm should adopt a differentiation strategy when it seeks to make its products and services attractive to buyers by other factors than cost. It can achieve differentiation by number of factors such as, product innovation, unique design, strong brand image and method of delivery to consumers, although this also depends on what values customers perceive to be important (Porter, 1985). Apple is associated with a clear market positioning and a unique brand image.

Thus, Apple can utilize the strategy of differentiation to create value for the iPad in various ways. Firstly, the product is superior and unique in that the product would be the first device of its kind to hit the market and therefore possessing a strong head-start. Additionally, Apple has a large developer base, which is something that would be very hard for the competition to compete with as many of them would still be in the development process of the tablet itself. This is in addition to Apple’s strong brand name and its huge customer base forming a large of pool of buyers of Apple products that can seamlessly integrate with each other including the iPad, enabling them to achieve product superiority with the iPad.

Furthermore, the presence of thousands of applications that are easily downloadable gives potential iPad users an unparalleled convenience to download applications on the go wherever and whenever they need it, thus increasing productivity. Another attractive and unique feature of the iPad is its ability to play games on an entirely different platform and experience to users. These features make the iPad highly desirable as a tool for personal productivity as well as the social qualities due to the fact that its features have been designed with the consumer in mind making it very user-friendly.

Evaluation of the indifference curves

Assuming Apple starts at point A whereby price is at and quality is at , along the indifference curve labeled . However, if Apple adopts the strategy of benefit advantage first, this will cause Apple to move to point B which is on a lower indifference curve , with price of the iPad being at since Apple is able to charge customers a higher price for the additional perceived benefit consumers receive from the good, resulting from the increase in quality from to .

Additionally, as the indifference curve of Apple has shifted to the right, the market will also attempt to compete with Apple by producing products similar to the iPad, thus increasing its quality as well as charging a lower price to attract more consumers since it is unable to reach the same level of quality as Apple for the iPad product. Thus, the market curve will shift from to and the benefit advantage of Apple will be diminished as all firms will now be able to provide consumers with the same amount of CS. However, this is not advantageous to Apple. If Apple decides to adopt the strategy of cost in addition to its strategy of benefit, it will be able to provide customers with the same amount of quality but with reduced costs, shifting its indifference curve further to the right from to , enabling it to provide higher value to consumers.

Consequently, the expected price of Apple’s competitors would be whereby the given quality intersects the market curve at point C, assuming cost remains the same. Hence, as seen in Figure 1, using benefit advantage, by setting a high price for a perceived higher quality by customers due to its high existing market share and brand image, it would be able to set its price at and quality at . Furthermore, if Apple combines this benefit with its cost advantage , it would be able to earn a higher amount of profit ( – ) per unit of output compared to its competitors ( – ).

Conclusion

To conclude, competitive advantage is at the heart of any strategy and if a firm is to attain a competitive advantage, it is required to make a choice about the type of competitive advantage it seeks to attain and the scope of its strategic target within it will attain it. (Porter, 1985). Although Porter views cost leadership and differentiation as mutually exclusive strategies and argues that a firm that attempts to pursue both is ‘stuck in the middle and is almost guaranteed low profitability. In practice, few firms are faced with such stark alternatives to choose between whether to differentiate or be a cost leader. Consequently, it is important to be nimble footed to establish a tradeoff between price and quality and cost advantage so as to maintain a competitive advantage.

However, I believe Apple is uniquely positioned in the market to make use of both advantages. This is because, high levels of advertising and promotional expenditure can increase market share, which then permits the exploitation of scale economics in advertising and other differentiation activities means that a market share leader can improve its relative cost position by forcing rivals to compete on product differentiation (Grant, 2010). Therefore, considering Apple’s potential good head-start and its superior value, demand of the iPad is likely to be high. If I were the CEO, I would adopt a strategy counting on the strong value created through the product differentiation, its quality and reputation to gain maximum revenue for Apple company as well as combining it with a lower-cost of production.

It is based on this and the above evaluation that has lead me to decide that there is no “one-size fits all” strategy. The best strategy for the iPad to take so as to gain competitive advantage would be one of differentiation advantage at first, followed by cost advantage thus maximizing profits and gaining a larger market share.