The 2 Effective Types of Differentiation in Business

This article is an excerpt from the Shortform book guide to "Winning" by Jack Welch and Suzy Welch. Shortform has the world's best summaries and analyses of books you should be reading.

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What are the two types of differentiation in business? How can you make your company stand out from the rest?

In Winning, Jack Welch advocates “differentiation,” one of his most influential yet controversial ideas. The basic principle of differentiation is that you remove the worst people, products, and services in your company and keep the best.

Keep reading to learn more about product and employee differentiation in business.

What Is Differentiation?

Differentiation in business is a process in which you identify the best- and worst-performing people, products, and services within your company, then nurture your best performers and remove your worst. Welch claims that differentiation can greatly improve your organization’s chance of success.

(Shortform note: As a business term, differentiation usually refers to product differentiation, in which a company tries to make its products or services stand out from the competition. Product differentiation is focused outwardly on other companies and products. However, when Welch speaks of differentiation, he’s inwardly focused, seeking to improve the company’s value by differentiating between and improving its products, people, or practices. For GE during Welch’s tenure in the 1980s, differentiation meant eliminating 100,000 jobs, dropping poorly performing products like clocks and TVs, and expanding into financial services and broadcasting.)

When it comes to products or services, differentiation means determining the most profitable sectors of your business and allocating resources to those key areas. With people, it means promoting or rewarding your best employees and firing your worst. Let’s look at both approaches.

Product Differentiation

Welch says that every company has its strong products or services and that investing more heavily in these will help your company flourish. To do this, you must first determine the criteria for what makes a “strong” product or service. For a large corporation, the definition of strong might be related to the product or service’s market share or growth rate. For smaller companies, you might determine your strongest products or services by the amount of revenue or profit they generate. Whatever your criteria, you need to have a clear understanding of the strong and weak parts of your business.

Once you know your business’s strengths and weaknesses, Welch recommends committing your resources to the strengths and removing the weaknesses. For a corporation, this might mean selling off the parts of your business that don’t have a steady market share or aren’t growing quickly enough. For smaller businesses, this might mean allocating all your marketing to your most profitable product and removing the least successful products from your catalog. According to Welch, committing and adhering to this process may hurt short-term revenues but will benefit the long-term health of your organization, as it ensures the underperforming parts of your business don’t languish and chip away at profits.

Other Factors to Consider Before Differentiating

Before fully committing to Welch’s strategy of bolstering your company’s strengths and removing weaknesses, you may want to consider a few other variables. In The Marketing Plan, William Luther says you should understand key variables about your product’s chance of success, and these variables may also affect how much you want to commit to a product or service. Let’s look at two of the variables Luther recommends understanding:

Market size: This is simply the total number of potential customers for your product or service. If you have a successful product, but it has a relatively small market size, it may be best to allocate resources to other products with a larger market size and thus more room for growth.

Market Life Cycle: It’s important to know what stage of the market cycle your product is in. According to Luther, there are three stages: introductory (when a new product or service hits the market), early growth (when the product or service begins to gain traction and consumer interest picks up rapidly), and late growth/decline (when the product or service is widely available and the leading companies are established). If you determine one of your strongest products by revenue is in the late growth stage, you might consider allocating resources to a weaker product in the introductory or early growth stages instead. Sometimes, it may be best to go against Welch’s advice of cutting out weaknesses.

Employee Differentiation

The more controversial side of differentiation is employee differentiation, which involves systematically firing your worst-performing employees.

Welch provides a specific method to implement employee differentiation: the 20-70-10 rule. The 20-70-10 rule recommends categorizing your workforce into the top-performing 20%, the middle 70%, and the bottom 10%. Then, reward the top performers, keep the middle, and fire the bottom. Though Welch admits that implementing employee differentiation can be brutal, in the end, it’s both an effective and moral practice.

Welch claims that employee differentiation is effective because it promotes candor and motivates employees. In a company that uses differentiation, employees know where they stand and if they need to improve. While some say that differentiation can be demotivating to the middle 70%, Welch claims that most people in the middle 70% will try to reach the top 20% to receive rewards such as bonuses, stock options, or promotions for their work. Furthermore, when the top performers aren’t rewarded for their production, they can become less motivated, which will substantially harm the business.

Welch further claims that, despite the controversy surrounding it, employee differentiation is moral for several reasons. First, retaining underperforming employees isn’t doing them any favors. Eventually, these underperformers will probably have to be let go, so it’s best to get it over with. Second, differentiation involves honestly assessing an employee’s performance, which, along with the threat of potential termination, will help employees either improve or find something they’re better at. Finally, differentiation is moral simply because it’s necessary in order to stay competitive in today’s business world. If you don’t do everything in your power to improve your business, it’s likely to fail, and then everyone loses their jobs, not just the bottom 10%.

The 2 Effective Types of Differentiation in Business