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Some products are commodities, identical regardless of the producer. Others are very different an people look for specific brands of whatever they buy. Has anybody built any sort of index of how differentiated a product is or an industry? This would be very useful for research purposes!

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    $\begingroup$ Possibly the cross-price elasticity could help you. But it only applies to two goods. $\endgroup$
    – HRSE
    Jul 20, 2016 at 2:09

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For an industry, one indicator used by competition authorities is the Herfindahl–Hirschman Index measured as $\displaystyle \sum_{i=1}^N s_i^2$ where there are $N$ firms in the sector and the market share of the $i$th firm is $s_i$.

This gives a value of $1$ when there is a single firm and $\frac1N$ when the $N$ firms have equal market shares, but also deals sensibly with cases where different firms have different shares.

For a particular product, you could look at something else like comparing its price elasticity of demand when other similar products do not change price, perhaps comparing this with the price elasticity of demand for all the similar products together. An undifferentiated product should have an almost infinite price elasticity as all demand will shift if there is any relative price change.

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To be honest I am not sure how Henry's answer could be the accepted one. The HHI is meant to measure market concentration that is a different concept from product differentiation: in an industry producing a commodity I can have thousands of firms, HHI would indicate that there is competition in the market, and yet the product is undifferentiated.

Price elasticity may be a viable indication for individual products since substitutability is influenced by product differentiation, yet this is not a specific index.

I would estimate a discrete choice model trying to grasp the weight of each feature of the product for its demand. The larger the relevant feature space of a product the higher the rate of differentiation of the single product.

Additionally, you may look at how spread apart are the firms in the feature space. Take the car industry as an example and for simplicity consider as relevant only horsepower and size of the car as our relevant feature space. Analyze the distribution of firms in this feature space, and as a proxy of it, the variance in the sample of these two characteristics may give you indication of how product differentiation in the industry.

EDIT: yrs later

Found two references that do exactly the last paragraph:

  1. Hoberg, G. and G. Phillips (2010). “Product market synergies and competition in mergers and acquisitions: A text-based analysis”. In: The Review of Financial Studies 23.10, pp. 3773–3811.

  2. Hoberg, G., G. Phillips, and N. Prabhala (2014). “Product market threats, payouts, and financial flexibility”. In: The Journal of Finance 69.1, pp. 293–324.

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