What are threats of substitute products?

A substitute product is one that may offer the same or similar benefits to a company as a product from another industry. The threat of a substitute is the level of risk that a company faces from replacement by its substitutes. For more generic, undifferentiated products the threat is always higher that from more unique products. A company that has several possible substitutes that can easily be switched to has little control over the prices it sets or how it chooses to sell the product.

© Entrepreneurial Insights based on the concept of Porter’s 5 Forces

Porter defined this threat as one of the forces that affect competitive structure within an industry. It is an important factor because it affects company and industry profitability. A low threat from substitutes means that there will be less competition among the existing firms and there will be more potential to earn higher profits.

In this article, we will look at an 1) introduction to the threat of substitutes, 2) conditions that increase the risk of substitutes, 3) analyzing the threat of substitutes, 4) mitigating threat of substitution, 5) capitalizing on the availability of substitutes, as well as 6) example from the soft drink and 7) example from airline industries.

INTRODUCTION

The existence of substitute product offers customers different choices and allows them options within the industry and beyond it to products that may fulfill a similar need. In more generic products, there are often more than one ways to address a particular need. An example of this is the option to choose different modes of transportation when going from destination A to destination B. If an airline operates on that route, it must compete with all other airlines on that route as well as any possible ground routes such as car rentals, buses and trains.

Analyzing the threat of substitutes can be tricky because any items being compared are not exactly alike but vary either slightly or greatly in what they offer. A customer will often base their analysis on the value offered by an item and its price.

CONDITIONS THAT INCREASE THE RISK OF SUBSTITUTES

There are many situations or conditions in which the threat of substitutes is stronger than usual. Some of these conditions are:

• Switching Costs: If there are little of no switching costs for a consumer, then there is more of a chance that they may explore and move over to a more attractive substitute. In the absence of other factors such as brand loyalty or differentiation, the choice to move will not be a difficult one. For example, if a consumer wants to replace cable subscriptions with online streaming site subscription, they may be able to do so easily unless there is some cost associated with discontinuing the cable service.

• Product Price: If substitutes are priced more reasonably, then there may be more risk of consumers switching products. In addition, this can act as a barrier to how much a company can raise the prices for its own product. Any move to price higher than substitutes may lead to consumer migration and loss profits.

• Product Quality: If the quality of substitute products is higher than that of any product, then it is more likely that consumers will want to make use of this difference and switch over.

• Product Performance: If a substitute products functions at the same level or at a better level than a product than there is a chance that consumers will want to switch over. For example, in travelling short distances, if an airline’s flights are always delayed, while a train or bus is on time, customers may choose to travel by road rather than wait endlessly for a plane to take off.

• Substitute Availability: All of the above factors can only come into play if there are actually substitutes available in the market. To identify potential threats, the company needs to be creative in its thought process and look beyond traditional competitors.

ANALYZING THREAT OF SUBSTITUTES

As mentioned previously, substitutes are not immediately recognizable since they are often from outside the industry a company operates within. This is why there needs to be special attention paid towards identifying the threat of substitutes and developing strategies to counter it in the long term. There is always the danger that a company may be too focused on handling its direct competitors and may miss the imminent threat of a substitute. This can even happen at an industry scale, where in the effort to compete with companies within the industry can overshadow threats from the outside.

A company can keep a check on possible substitutes by doing the following:

Identify Problems

Identify the problems that can be solved by your product or service? These should be listed down in detail and creative thought through in order to generate as close to an exhaustive list as possible.

Identify other Solutions

Now identify what other means exist to solve the same problem. What can be reasonable alternates that a consumer may consider?

Identify Substitute Appeal

At this point, try to understand why an alternate solution may be appealing to a consumer. Some questions to ask here may be:

• What are benefits that your product doesn’t provide but the alternate does?
• What are the price points and how do they differ?
• Can prices change suddenly? If so, why?
• Are there any weak points in the substitute item? Are there any limitations to its use?
• Are there any barriers that may stop a customer from switching?
• Are there any trends that define the substitute products industry? What aspects are responsible for value to the customer?

Create Counter Measures and Strategies

With understanding of substitutes, how they work and the basis of their possible appeal to consumers, the company can now create strategies to handle these alternates. There can be two sets of strategies. One to prevent customers from leaving for a substitute and the other to entice people over from a substitute.

Determining Threat Severity

The severity of a substitute’s threat to consumers of a product can be determined by asking a series of questions. If any one of more of these applies then the product may be under threat from substitute products.

• Are consumer switching costs low?
• Are substitute products cheaper than yours or other competing products within the industry?
• Are substitute products similar in quality or better than yours or other competing products within the industry?
• Are substitute products performing better than your product or other competing products within the industry?
• Are there one or more substitutes available in the market?

MITIGATING THREAT OF SUBSTITUTES

Though not foolproof, there are steps to take in order to prevent customers from needing to explore alternates or substitutes. These include:

• Differentiation: Through creating a unique product offering, customers will be able to satisfy a need through only a specific product and will not be easily swayed by substitute products. There could be additional features or benefits that may not be available in a substitute product.

• Customer Value: Customers often look for the product that provides the best value for money. This means that maximum benefits are being gained by spending the least amount of money. If this value is created for a customer than they may not need to look at other products

• Brand Loyalty: Most companies strive to create and maintain a strong brand loyalty among their customers. This helps prevent easy switchovers to other brands or substitute products.

CAPITALIZING ON THE AVAILABILITY OF SUBSTITUTES

If substitute products have been identified and there is a threat of easy switching between a company’s product and the substitute, then a company can act preemptively and try to bring over customers over to their product. A company can:

Identify Consumers With the Potential To Switch Over

The first thing a company can do is to identify those members of the potential audience that are most likely to move to a substitute. This group may collectively have an unmet need or a weak spot. An example could be unhappiness with the business practices of a company or an industry.

Communicate and Build a Relationship with Them

Once the target audience has been identified, a company may want to find ways to interact with these people and create a relationship with them. This could be through special information sessions, point of sale interaction or specialized mail or advertising.

Educate Them About The Company’s Product

Once a line of communication is opened, information can be shared about the product being sold by the company and the benefits and features it can offer.

Offer Special Packages or Trial Purchases

In order to encourage these consumers to take the first step towards change, it is a good idea to offer them special discounts, package deals or trial purchases. This may help ease the process of change and create value in the consumer’s mind.

Reassure Constantly

In order to solidify the new relationship, consumers may need to be reassured that their needs are met and possibly in better ways than before. The established line of communication needs to be strengthened and after sales service and communication needs to continue.

Work Towards Building Customer Loyalty

Through sustained good relationships, good service and continued value for money, customer loyalty can be created and built up over time.

Work Towards Maintaining Customer Loyalty

Sustained customer loyalty is the way to ensure that customers will not switch back to their old product. Discounts and offers will only go so far. For long term relationships, it is vital to try to ensure that the product remains good value for money, it remains functioning at an optimal level of quality and it continues to fulfill an unmet need for the consumer.

EXAMPLE – COCA COLA

© Wikimedia commons | The Coca-Cola Company

Produced by the Coca Cola Company, ‘Coke’ is an extremely popular carbonated beverage sold all over the world. When it was invented in the 19th century, the product was intended to be used as a medicine. It was later purchased by a businessman, who used clever marketing to position it as a soft drink and eventually led to the brand’s global position today.

The company operates through bottlers worldwide. Concentrate, made with a secret formula is sold to these bottlers who complete the product and sell it in its various forms in their designated markets. Apart from bottlers, concentrate is also sold to restaurants and fast food chains to be used in soda fountains.

As of 2013, Coke and related products were available in more than 200 countries all over the world. Coca Cola remains the most valuable brand in the world according to a study conducted in 2011.

Competitors and Substitutes

The soft drink industry faces intense competition from within its industry as well as from substitutes. The most major of its competitors is Pepsi Cola which competes in all the same markets and even outsells it in some of them. Other direct competition comes from local cola drinks, as well as other soft drinks. Close competition comes from items like fruit juices and other similar beverages. Alternates or substitutes can include water or even coffee or tea as sources of caffeine.

The Threat of Substitutes

There is medium to high pressure from substitutes in the beverage industry. As a product, most people cannot differentiate the taste from other similar cola products. So for many, it is an interchangeable product. In addition, the rising awareness of cola products and their negative repercussions on health have led to other beverages such as water and juices becoming more sought after.

There is an ever increasing variety of sports and health based drinks in the market. In addition, chain stores such as Starbucks now offer a large variety of products that cater to different tastes. These also affect cola sales. For those looking for a caffeinated drink, there is always coffee and tea, both of which are now available in a myriad of flavors and tastes.

There are low switching costs associated with a move from the product to another. While Coca Cola does enjoy some brand loyalty, this usually extends to refusal to drink another cola but not a refusal to consume another beverage altogether. The quality of the products, both competing soft drinks and substitutes are similar enough for the quality factor to not be an anchor for existing consumers.

It remains in the interest of the cola industry to attempt to keep consumers within the industry. This means that collectively, any positive advertisements from one company can lead to a resultant increase in the sale of all colas or soft drinks. While any negative public relations related to the industry will drive all consumers away from the product regardless of their brand choices and preferences. For this reason, soft drink companies have huge marketing and advertising budgets and a lot of effort goes into creating and maintaining brand visibility and loyalty.

EXAMPLE – THE AIRLINE INDUSTRY

© Wikimedia commons | Charaka Ranasinghe

From the point of view of airlines themselves, the flying business is very competitive. There are hundreds of airlines all trying to get a bigger piece of the pie. Global recessions have also meant cost cutting exercises for most airlines in the industry and often less travel in the part of consumers. There is also the trend to move from government owned carriers to more privately owned enterprises. This means that there can be no subsidies during times of crisis and no bailouts. Other issues faced include airport capacity, the structure of roots, costs to buy, lease or maintain aircraft, adopting new technology, weather fluctuations, increased security requirements and checks, fuel and labor costs, as well as issues.

There are four types of airlines divided by the types of services they provide. These include:

• International Airlines
• Domestic Airlines
• Regional Airlines
• Cargo Airlines

Threat of Substitutes

Depending on the nature of the airline’s business, the threat of substitutes can range from lower on the scale to mid-range. For domestic or regional airlines or routes, there is always the option of taking a car, bus or train. It may take longer but often this consideration is outweighed by the cost advantages of substitute methods. There is also no switching cost to deal with.

In the case of international airlines, the threat of substitutes is almost non-existent. On longer routes, a traveler needs to take a flight with no possible alternates. Threat here is from competitors who may offer better rewards, better prices or a better flying experience. There is also somewhat of a switching cost. Airlines offer miles that collect to offer rewards. If these collected miles are divided over multiple airlines, benefits are also divided and slow to accumulate.

Image credit: Wikimedia commons | The Coca-Cola Company under public domain and Wikimedia commons | Charaka Ranasinghe under Attribution 2.0 Generic.