Explaining the Threat of Substitute Products
Substitutes are products that do the same job for your target customers although they are different in nature to your company’s product.
Butter and margarine, beer and wine, coffee and tea are all classic examples of substitute products. They are a threat to profitability because they put a cap on the prices that you are able to charge for your products and services.
For that reason, “substitutes”, as they are also known for, can limit the profitability of your business and must be taken into account as part of your business strategy.
The threat of substitute products tends to be low if buyers face high costs when switching over to the substitute.
For example, if a company outsourcing its graphic design wanted to do the work in-house, they would need to consider the cost of buying specialized software licenses, powerful graphic computers and other tools when evaluating the switch, and the higher the cost of internalizing the design work, the lower the incentive to switch.
For that reason, the vendor (in this case the design company) must keep its prices low enough to make the buyer’s decision to switch a bad financial decision, but high enough to maximize its margins.
A new take on identifying substitute products is Professor Clayton Christensen’s Jobs to be
This framework proposes the idea that products are “hired” by customers to do a job that they need to get done.
A low-carb diet for example can help a young woman lose weight quickly, but we could also say that the “job” the diet does for her is to make her look in better shape for a wedding next month.
This alternative way of thinking can help you see how diets then compete with products from other industries like apparel, corsets, make-up and others that could also make the buyer look better in a short time.
Focusing on the “jobs” that need to be done, rather than just segmenting a market by demographics, helps you see the true competition that your products have.
No one could have put it better than legendary marketing professor Theodore Levitt when he said “People don’t go to a hardware store to buy a quarter-inch drill. What they want to buy is a quarter-inch hole in the wall!”
This article has been extracted from Sun Wu’s book Strategy for Executives which can now be downloaded for free here.
Porter, Michael E. Competitive Strategy: Techniques for Analyzing Industries and Competitors. Free Press. Kindle Edition.
Magretta, Joan. Understanding Michael Porter: The Essential Guide to Competition and Strategy. Harvard Business Review Press. Kindle Edition.