One of Porter’s Five Forces identified by Michael E. Porter can shape competition and determine the intensity of the competitive environment is the threat of substitutes or the threat of substitute products. Take note that the other four are the bargaining powers of suppliers, threat of new entrants, the bargaining power of buyers, and the intensity of competitive rivalry.
Defining and Explaining Substitute Products and the Threat of Substitutes
What Are Substitute Products? How Do They Affect Business Organizations, their Profitability, and the Competitive Environment?
A substitute product is a product from another industry that provides somewhat similar features and benefits from another product produced by a business organization within another industry or sector. This substitute product can also be in another product category or sub-category.
For a more technical definition, note that substitutes use different selling points or technologies to address the same economic need.
Porter explained that the threat of substitutes occurs when a business organization in a particular industry is compelled to compete with other industries producing goods or services that can provide the same features and benefits or address the same economic need.
Substitutes threaten the profitability or the earning potential of an organization because it provides consumers with better or more affordable options.
Organizations that produce or provide goods or services for which there are no close substitutes have better earning potential. Furthermore, they have more freedom to determine prices, thereby allowing them to increase prices to maximize profitability.
What Are Some Examples of Substitute Products? What Are the Specific Examples of Firms and Industries Threatened by Substitutes?
Remember that substitute products provide somewhat similar features and benefits or address the same economic needs. Take note of the following examples:
• Beer and Wine: Both products are from the same liquor industry or alcoholic beverage market. However, wine is a substitute for beer because it is a different product that uses different ingredients and manufacturing processes.
• Landlines and Mobile Phones: These two are also within the same telecommunication industry. But landlines are wired mediums of voice communication while mobile phones are wireless communication devices that provide voice, text messaging, access to the internet, and other functionalities.
• PCs and Smartphones: Personal computers are used for productivity, entertainment, and communication. Smartphones are substitutes because they also provide the same functionalities but they are based on different technologies.
• Meat, Poultry, and Fish: These three food categories provide consumers with a source of protein and other macronutrients. However, if the prices of pork and beef are high, then poultry and fish can be substitutes. Some also consider that white meat from poultry and fish are healthier alternatives to red meat.
Coke and Pepsi are not substitutes because they are the same cola-based carbonated beverage. A more reasonable substitute for carbonated beverages is water or fresh juice. The same is true for different varieties of rice. A substitute for rice is quinoa or Adlai grains.
To understand better substitutes and their impact, the following are specific examples of businesses and industries threatened by them:
• Luxury Fashion Brands: Fast-fashion brands such as Zara and H&M provide substitutes to luxury or haute couture apparel because they are affordable and use a manufacturing process centered on fast and efficient production.
• Fast-Food Restaurants: The presence of other restaurants, alternative healthy food items, and grocery items for home-cooked meals prevent fast-food chains from dictating and raising the prices of their food items.
• Windows and Mac OS: The Android and iOS mobile operating systems, as well as desktop operating systems based on a thin client such as ChromeOS, are substitutes to traditional Windows-based and Mac-based desktop operating systems.
• Livestock Industry: Farm produces are an alternative to meat. Furthermore, with the rise of veganism, substitute meat products, especially vegetable-based food items are threatening the producers of pigs, cattle, poultry, and fish.
What Are the Factors Determining Whether or Not There is a Threat of Substitutes? How Do They Influence the Level of Threat?
Numerous factors can determine whether or not there is a threat of substitutes or, more specifically, if a particular business or industry is threatened by substitute products. Take note of the following factors:
• Consumer Switching Costs: The threat of substitute products is high if there is little to none stopping consumers from purchasing a substitute good or service, especially if the switching cost is low. A specific example would be a consumer buying fish because they are cheaper than meat from pork or cattle.
• Product Differentiation: Another factor that can determine whether or not there is a threat of substitutes is the selling points of the specific substitute products. Smartphones have a high perceived level of product differentiation when compared with desktop computers because they are more mobile and have other functionalities.
• Number of Substitutes: There are several substitute products in the consumer electronics industry that provide almost the same functionalities. These include personal computers, tablet devices, and smartphones, among others. The higher the number of substitutes, the higher the threat.
• Relative Price of Substitutes: The relative price performance of substitutes is similar to switching cost. Consumers would be attracted to purchase a substitute good or service if it is more affordable, thereby threatening the market attractiveness of other products, as well as the ability of their products to raise their prices.
• Ease of Substitution: Another factor that can determine if the threat from substitute products is high or low is availability and accessibility. The threat is high if consumers can readily purchase substitute products either because they are cheaper, have better product selling points, and are geographically accessible.
• Propensity to Substitute: Preference can also determine the level of threat. The threat is low if there is strong brand loyalty. Furthermore, it is also low of consumers have more penchant toward a particular product. Mobile phones are more preferred than other communication devices because they have become a necessity.