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.

Determining Factors

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.

Analysis

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.

Examples of Threat of substitutes

• The substitute is cheaper
• The substitute offers a better quality product or service
• The substitute has a better brand name or reputation
• The substitute has a superior customer service or support system
• The substitute offers a wider range of features or benefits
• The substitute is more accessible or available to customers
• Computers replacing typewriters
• TVs replacing radios
• Online streaming services replacing cable TV
• Online taxi services replacing traditional taxi services
• Electric cars replacing gas cars
• Paperless payments replacing paper checks

Advantages of Threat of substitutes

The threat of substitutes can be a powerful force in any industry, providing both advantages and disadvantages to businesses. On the positive side, the threat of substitutes can:

• Encourage innovation and creativity: Companies may be motivated to innovate or create new products or services in order to stay ahead of the competition.
• Increase competition in the market: The presence of substitute products or services can help to create a more competitive marketplace, which can benefit both businesses and consumers.
• Forces businesses to be more efficient: Companies may be encouraged to become more efficient and reduce costs in order to remain competitive.
• Create more choices for consumers: The availability of substitute products or services can provide more options for consumers. This can result in lower prices, improved quality, and better customer service.

Limitations of Threat of substitutes

The limitations of the threat of substitutes include:

• The availability of substitute products: Availability of substitute products is a limiting factor for the threat of substitutes, as the presence of a substitute may be low in the market, making it difficult for customers to switch from one product to another, reducing the threat of substitutes.
• Product differentiation: Differentiation in the product can also limit the threat of substitutes, as consumers may find a certain product more appealing than the substitute, making them less likely to switch.
• Cost of switching: The cost of switching from one product to another is also a limiting factor in the threat of substitutes, as switching costs such as time, effort, and money can deter customers from making the switch.
• Brand loyalty: Brand loyalty can also limit the threat of substitutes, as customers may be loyal to a certain brand and be less likely to switch to a substitute product.
• Consumer tastes: Consumer tastes and preferences can also limit the threat of substitutes, as customers may not be willing to switch to products that are not in line with their preferences.

Other approaches related to Threat of substitutes

The threat of substitutes is also linked to the other approaches, such as:

• The Availability of Substitute Products: The availability of substitute products can affect how much of a threat of substitutes a company faces. If a substitute product is readily available, the threat is likely to be high.
• The Quality of Substitute Products: The quality of the substitute product can also affect how much of a threat of substitutes a company faces. If the substitute product is of higher quality, the threat is likely to be higher.
• The Price of Substitute Products: The price of the substitute product can also affect how much of a threat of substitutes a company faces. If the substitute product is cheaper, the threat is likely to be higher.
• The Brand Equity of Substitute Products: The brand equity of the substitute product can also affect how much of a threat of substitutes a company faces. If the substitute product has a strong brand, the threat is likely to be higher.

Conclusions

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.

Threat of substitutes — recommended articles

Substitute goods — Prestige products — Free competition — Bargaining power of buyers — Bargaining power of suppliers — Trade allowance — Normal good — Veblen effect — Clientele effect

References

• 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