Substitute products: Why managers need to be aware of substitutes

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What are substitute products?

Substitute products outside of your industry that meet the same or a similar function as your offerings. Despite using different inputs as your firm (such as different materials, manufacturing processes, types of employees), substitute products may offer a similar benefit to customers. Indeed from a customer’s perspective, the goods may be almost indistinguishable. 

Example of substitute products: Glasses vs contact lenses

One classic example of a substitute product is glasses and contact lenses. From a customer’s perspective, both options meet a similar need of correcting vision. People may have preferences for one vs. the other, but ultimately, they both meet a similar need. 

From the ‘input’ side, however, glasses and contact lenses are both remarkably different – they use different technologies and manufacturing processes. The companies involved in both areas are different. They also have a slightly different revenue stream – a constant revenue stream in the case of contact lenses vs. one-off purchases for glasses. 

Example of substitute products: Ride-sharing vs. taxis

Another example of a substitute product is the difference between ride-sharing (such as Lyft and UberX), and the taxi industry. From the customer’s perspective, these may be very similar offerings – they are both ways of getting a ride from one location to another. The ‘inputs’ involved in both offerings are however very different – while taxi firms have the fleet of vehicles, Uber and Lyft are essentially software companies, focused on the app development and building a network of drivers and users (without actually owning the taxis themselves).

A similar distinction can also be made between hotels and AirB&B – while hotels directly manage the property, employing cleanser and receptionists, AirB&B relies on a network of homeowners who list their homes on the platform – a very different sort of company from traditional hotels, even though from the customer perspective, these are similar offerings. 

The impact of substitute products

Substitute products compete with your offerings in a similar way to products within your industry. While customers may have preferences for a particular offering (e.g., glasses vs. contact lenses), should the prices of one increase, customers are likely to switch to the other.

Why substitute products are not always fully considered

One of the real dangers of substitute products is that they are not always fully considered by managers in the main industry. Managers often mainly focus their attention on considering firms that look similar to them – similar inputs and manufacturing processes. This leaves the danger that substitute products can grow potentially without the awareness of managers focused solely on their own industry.

If we take taxis as an example – the rise of Lyft and Uber – which operated with a different model – caught traditional taxi firms by surprise. Yet, these tech firms, which had a very different setup to traditional companies, very quickly became a substantial threat to traditional taxi companies, that had a difficult time adapting to this new rise of competition. 

The danger of substitute products: Gradually improving in performance over time

Part of the danger of substitute products is that they can gradually improve over time – potentially without the awareness of managers focused on their own industry. 

Responding to substitute products may also be further complicated if they have developed capabilities that your firm does not have. Their different resource base may be challenging to develop making it difficult to know how to respond.