Porter’s threat of substitutes definition is the availability of a product that the consumer can purchase instead of the industry’s product. A substitute product is a product from another industry that offers similar benefits to the consumer as the product produced by the firms within the industry. According to Porter’s 5 forces, threat of substitutes shapes the competitive structure of an industry.
Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces, such as it being a buyer’s market.
The threat of substitution in an industry affects the competitive environment for the firms in that industry and influences those firms’ ability to achieve profitability. The availability of a substitution threat effects the profitability of an industry because consumers can choose to purchase the substitute instead of the industry’s product. The availability of close substitute products can make an industry more competitive and decrease profit potential for the firms in the industry. On the other hand, the lack of close substitute products makes an industry less competitive and increases profit potential for the firms in the industry. A threat of substitutes example is the beverage industry due to a market with many competitors.
Threat of Substitutes – Determining Factors
Several factors determine whether or not there is a threat of substitute products in an industry. First, if the consumer’s switching costs are low, meaning there is little if anything stopping the consumer from purchasing the substitute instead of the industry’s product, then the threat of substitute products is high. Second, if the substitute product is cheaper than the industry’s product – thereby placing a ceiling on the price of the industry’s product – then a threat of substitutes high risk is the case. Third, if the substitute product is of equal or superior quality compared to the industry’s product, the threat of substitutes is high. And fourth, if the functions, attributes, or performance of the substitute product are equal or superior to the industry’s product. Any of these situations is a high threat of substitutes: porter’s 5 forces sees less profit potential.
On the other hand, if the substitute is more expensive, of lower quality, its functionality does not compare with the industry’s product, and the consumer’s switching costs are high, then a low threat of substitutes occurs. And of course, if there is no close substitute for the industry’s product, then the threat of substitutes is low.
Threat of Substitutes – Analysis
When analyzing a given industry, all of the aforementioned factors regarding the threat of substitutes may not apply. But some, if not many, certainly will. And of the factors that do apply, some may indicate high threat of substitutes and some may indicate low threat of substitute products. The results will not always be straightforward. Therefore, it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.
The Threat of Substitutes Porter places High risk on:
• Substitute product is cheaper than industry product
• Consumer switching costs are low
• Substitute product quality is equal or superior to industry product quality
• Substitute performance is equal or superior to industry product performance
The Porter Threat of Substitutes Low Risk Situation:
• Consumer switching costs are high
• Substitute product is more expensive than industry product
• Consumer switching costs are high
• Substitute product quality is inferior to industry product quality
• Substitute performance is inferior to industry product performance
• No substitute product is available
Threat of Substitutes Interpretation
A low threat of substitute products makes an industry more attractive. In addition, it increases profit potential for the firms in the industry. Conversely, a high threat of substitute products makes an industry less attractive. It also decreases profit potential for firms in the industry. The threat of substitute products is one of the factors to consider when analyzing the structural environment of an industry using Porter’s 5 forces framework. Start creating a list of potential substitutes that you evaluate as a threat in an external analysis. With this analysis, you’ll be better able to identify and react to any threat of substitutes. Download the free External Analysis whitepaper by clicking here or the image below.
[box]Strategic CFO Lab Member Extra
Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.
Click here to access your Execution Plan. Not a Lab Member?
Click here to learn more about SCFO Labs[/box]