Threat of substitutes
|Threat of substitutes|
Threat of substitutes is part of Porters Five Forces. It comprises a substitute product that may offer the same value proposition from a different industry. It is essentially the level of risk that a company in a certain industry faces from potential products that could replace it. In general, this specific threat has several elements that can increase or decrease it. These include if:
- the product has high switching costs;
- the quality of the product;
- the availability of substitutes.
Switching costs can consist of actual monetary costs like buying a coffee maker instead of drinking tea but can also mean lifestyle choices such as biking instead of driving everywhere. If it is easy to switch or cheap to switch products that means that the threat of substitute is high. If in general the quality of products produced is high, consumers have less of a reason to switch to a substitute as their needs are being met. The availability of substitutes is also a major factor; if your product is very niche and no other item can complete the same function then consumers have no choice but to continue to use the product .
These factors all influence how much danger a product can potentially be in from substitutes. It is because of this that there are strategies companies use to mitigate the threat of a substitute. Brand loyalty is effective in this as consumers, if loyal to a brand find it difficult to switch to other products. Generating value with products also mitigates this threat because offering consumers the best benefits for the money they spend retains customer loyalty. The most important one however is having product differentiation. Creating a product that is unique and satisfies a specific need will largely deter the threat of substitutes for a company.
An interesting analysis on the concept of the threat of substitutes was done regarding the Cooperative Bank of Kenya Ltd. This market previously had several local banks but in recent years has been flooded with multiple international banks. This emergence of international banks has critically increased competition within the industry in the country. The increase in new entrants, another Porters Force, is causing turmoil in the market and one of the major substitutes of many banks is growing in popularity. In Kenya many people are switching to Savings and Credit Societies that have lower interest rates and fewer restrictions on how people handle their money. The loan services they provide are also not as strictly regulated by the government compared to the major banks. Much like a snowball effect, the increased competition has forced the Cooperative Bank of Kenya to cost cut and some of their services have degraded. This combined with the better offers provided by the Saving and Credit Societies prove that it is a harsh environment for the banking industry in general at the moment in Kenya .
The sweet corn industry in Thailand also provides an interesting take on the threat of substitutes. Sweet corn is a major crop in Thailand with large amount of consumption and production at the same time. There have been many recent pressures on this industry as other industrial crops make more money for famers, there are no subsidies for growing sweet corn and there is foreign competition for the crop as well. The threat of a substitute product in this case mostly involves products similar to consumers like beans and grains, also foods that have similar nutrition like potatoes and other high fibrous foods. Even under the pressures the sweet corn industry is in, these other products still cost more but people are slowly switching their consumption patterns. Consumers are also looking at the quality of the substitutes and people are becoming more health conscious so moving away from sweet corn is natural. The trend recently has been towards foods that are healthy in terms of sugar levels, sodium, high in vitamins and fiber while also being appealing to the smell, appearance, texture and taste. The switching costs in this case might not seem that high as it is a simple decision to buy other foods but in Thailand sweet corn is engrained in the culture so lifestyle switching costs are high. The price of these substitutes is also still higher than sweet corn although that may change soon. In most situations sweet corn might not seem like a niche product as nutritionally it can be replaced but the cultural importance it has provides it with additional protection against substitutes in the country .
The threat of substitutes is an essential part of Porters Five Forces and the many elements surrounding it are important in understanding the competitive advantage a product or company has. The Kenyan bank and Thai sweet corn industry also illustrate how the threat of substitutes is complicated and needs to be understood well to properly identify the competitive advantage a product has in a specific market.
- Indiatsy, C. (2014). Application of Porter’s Five Forces Model on Organization Performance:A Case of Cooperative Bank of Kenya Ltd. "European Journal of Business and Management", Vol. 6, Nr. 16, Mar.
- Rachapila, Tanakorn (2013). Using Porter’s Five Forces Model for Analysing the Competitive environment of Thailand’s Sweet Corn Industry, "International Journal of Business and Social Research (IJBSR)", Vol. 3, Nr. 3, pp. 174–184.
- Valuation Academy (2018).Porter's Five Forces- Threat of Substitute Products or Services, "Valuation Academy RSS".
Author: Oleksandra Zaika