In previous blogs we have given an overview of Porter’s Five Forces and talked about how businesses can use this strategy, as well as focusing on the first of the Five Forces: Potential Entrants. Now in this blog we are looking at No 2: Substitutes.
What are Substitutes?
A substitute is something that fulfils customer needs in a way that rivals the original product or service. This can vary from industry to industry. As with all of Porter’s Five Forces, analysis of the threat of substitutes can help a company to make strategic decisions and to implement change that will allow the business remain competitive.
What is the danger of substitutes?
If a company supplies a product or service that has several substitutes, the amount that the company can charge for what it offers is restricted, as customers have alternative options if prices become too high.
Generally speaking, the fewer substitutes on the market, the greater the potential for price increases.
What are examples of substitutes?
The rise of digital technology, fed by continual innovation, is a good demonstration of how substitutes can challenge formerly market-leading products.
Taking music as an example, in a time period spanning around 50 years, records faced substitution from cassettes then CDs and now downloading. The hardware that plays different types of music has also changed over the years. However, the fact that records are now returning to popularity demonstrates how substitutes do not always make the original product obsolete.
A similar situation is found with paper books, which many thought would be replaced completely by digital books on eReaders, but which have rallied in sales to exist side by side.
In industry, automation has frequently become a substitute for manual labour, but each level of automation can itself be threatened by more advanced automation as technology advances. This is particularly likely to be the case when the initial outlay on capital expenditure has a fast payback due to increased productivity, reduced energy bills and cost savings.
Cost savings are not always a factor, for example a consumer might choose to pay more for a face cream that promises better results, when switching to organic vegetables, or for a holiday in an adults-only resort.
When considering services rather than products, an example of a substitute could be a business outsourcing its cleaning to reduce the payroll costs of hiring cleaners.
When are customers most likely to switch to substitutes?
If a company is facing one or more rivals offering substitutes, customer loyalty becomes even more important, especially if the substitute offered is cheaper or easier to use. Barriers to switching can also be a factor, for example if the substitute product is not compatible with other products the company uses, or if the customer is tied into a long contract.
As well as cost, the performance of the substitute is a key driver in whether customers are likely to switch. For example, a business operating a warehouse may switch from a manual system of picking goods to a more expensive digital system – and invest further costs in training staff – because the substitute new system improves the speed and accuracy of the picking, saving money in the long run.
Any company faced with substitutes should consider the best options for remaining competitive. This could be by rewarding customer loyalty, redesigning their products, upgrading their services or creating distinctive branding – fashion clothes and trainers are a good example of this – that makes their product or service more desirable than the competition.