Staying Competitive just doesn’t mean staying one step ahead. The next Marketing threat is the threat of substitutes. A substitute is a product or service provided by a firm’s rivals that meets approximately the same customer needs in the same ways as the product or service provided by the firm itself. As indicated by Porter’s five forces model, substitute products will cause an indirect threat to existing firms. This threat may not be as crucial as that from direct competitors; however, it can still be considerable. There are many examples from industrial history where a substitute product has completely wiped out industries. The presence of substitute products can lower industry attractiveness and profitability because they limit price levels. In a free market economy, buyers have the choice if there is a viable alternative.
The Best Example here would be the music and record industry, the main product of focus is the compact disc or CD. In 2007, roughly 83 percent of sales for the music recording industry came in the form of full-length CDs. This number was down from a high of approximately 91 percent in 2002. Therefore, the vast majority of record company sales and revenues come from CDs. So from the point of view of the large music groups, the biggest threat of substitutes comes from alternatives to CDs, in which there are plenty. Substitutes to CDs like mp3s and other downloadable formats place a ceiling on prices firms in the music industry can charge and on the profits those firms can make. In the extreme, substitutes can ultimately replace an industry’s products and services if they are thought to be superior. This remains a big question in the music recording industry, as to what extent online downloading of music will replace compact discs. Since music groups and labels have to charge less for their CDs, revenues for the company go down and this causes profits to decline in turn. One could even argue that total costs rise since these companies have to spend more money creating alternative and cheaper forms of music in addition to CDs. Also, since competition is tougher, advertising costs may be higher for companies who try to distinguish their products. Ultimately, the threat of substitutes is high and the industry experiences increased costs, decreased revenues, and therefore, decreased profits.
Whether a substitute product is really a threat depends upon a number of factors:
a. The existence of close substitute: The best example for explain this is Coke and Pespi as they are close substitutes of each other , as they have the same price, colour, packaging, almost the same taste and similar want satisfying capacity.
b. Switching costs: The greater the cost for customers to switch to substitute product, the less the threat there is of substitution.
c. Perceived level of product differentiation: People are less likely to switch to an alternative product if they think that it would be difficult to replicate all of the features of their original product. For Example Tea and Coffee.
d. Buyer’s propensity to substitutes: Customers in some markets are more likely to remain loyal to a product or service. In other markets customer loyalty is rare.
A low threat of substitute products makes an industry more attractive and increases profit potential for the firms in the industry, while high threat of substitute products makes an industry less attractive and decreases profit potential for the firms in the industry.
Few Examples of Substitute Product being a threat to the Industry:
a. From the early 80’s to the end of the millenium, telephone booths, STD-PCO booths had a stronghold over the telecommunication market. The PCO business was spread from metropolitan cities to remotest of villages, which showed tremendous potential of further growth as the world was becoming a smaller place. However in the late 90’s, the cell phone technology arrived and by the beginning of the century it took the market by a storm and completely destroyed the STD PCO market in the cities. It is still growing and threatens to kill the PCO booth business in the rural areas as well, due to better, easier and cheaper connectivity. Thus, the arrival of an innovative substitute leads to the downfall of the telephone booth market.
b. Another example of substitute services affecting an entire industry is that of low cost airline carriers eating up of share of the railway industry. Earlier, airline travel was considered to be a luxury as only a privileged few could afford to travel by air, while most people preferred travelling by AC trains, which was a lot cheaper. However, with the arrival of low cost carriers in the market like Deccan, Spice jet, Indigo etc, the customers had an option which was better than travelling by train. Not only were the airlines price competitive as compared to the railways, but it also reduced the time travel with better facilities for travellers at airport terminals compared to railways stations. Thus, customer’s preferred travelling by low cost airlines, which lead to a decline in the number of premium railway passengers travelling by AC trains. Therefore, innovation in services is also essential so as to act against threat of substitutes, and retaining market share against cheaper or better substitutes.
c. Similarly, another simple yet effective example of substitutes proving better than products is the threat of matchsticks for gas-lighters. A gas-lighter is very expensive as compared to an entire match box, which solves the same purpose of burning the gas stove, and thereby threatens the market share of the gas-lighter business.
Fighting competitors should be the priority for organisations in this competitive world because they crawl and eat into their business. But companies should be on the vigil and look out for products and services which can be a potential threat as it can substitute the existing product, and demolish its existence from the market.
Prof. Jharna Lulla
Faculty Economics and Placement Officer
International School of Management Excellence
The author of the article is Prof. Jharna Lulla, faculty at International School of Management Excellence, Navi Mumbai. She has done her Masters in Economics and PGDM. She has extensive experience in Industry before moving to academics. Prof. Jharna is currently writing a book on Macro Economics and is a prolific writer in journals and magazines.