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Threat of substitutes (from Porter’s five forces analysis)occurs when companies within one industry are forced to compete with industries producing substitute products or services.
Threat of substitutes is one of the five forces that determine the intensity of competition in an industry. The others are
Substitutes, potential returns, profits and competition
Substitutes limit an industry’s potential returns by placing a ceiling on the prices that firms within that industry can charge to make a profit. As the price-performance alternative offered by substitutes becomes more attractive, it becomes even more difficult for those firms to make a profit. Demand for substitutes can also reduce the demand for industry products and services. Substitutes can create intense competition during normal economic times, and reduce potential profit increases during positive economic times.
Identifying substitutes involves searching for other products or services that can perform the same function as the industry’s product or service. Positioning an industry’s products or services against the substitutes may take place via collective industry actions (for example, sustained advertising by industry participants).
Key substitutes
Substitute products that deserve the most attention include those:
- Subject to trends that improve their price-performance tradeoff with the industry’s product
- Produced by industries earning high profits—development increases competition in their own industries, causing price reduction or performance improvement
Read next: Barriers to entry: Factors preventing startups from entering a market
References
Porter, M. (1998). Competitive Strategy.New York: Free Press. pp. 25-26.
