Sometimes the boundaries between your industry and substitute industries are fuzzy. This article gives one perspective on the distinction – whether or not the goods and services are developed in a similar way (i.e., using similar production techniques and materials), or not. Those firms with similar approaches fall in your direct industry, while those firms providing for similar customer needs but achieving it in a radically different manner fall in the substitute industry.
Defining an industry
We can think of an industry as a grouping of firms that all meet a similar customer need do so in a similar manner:
- Similar customer need: The products produced by the industry are comparable in manner. There may be some differences in the exact features, but overall, firms produce roughly comparable goods.
- Similar operations and inputs: As well as meeting a similar customer need, the goods of an industry are also produced in a similar manner. Sometimes this is referred to as similarity in the ‘factor market’ – the inputs to production are approximately comparable. This may include similarities in the manufacturing operations, raw materials, or the skill-sets of employees of the firm.
Defining substitutes to your industry
We can think of substitute goods as those that while meeting a broadly similar customer need (although potentially slightly different in focus to your industry), have achieved this in a different manner:
- Similar customer need: As with firms in your industry, substitute goods meet a relatively similar customer need. The differences may be greater than firms in your industry though – there may be a different set of attributes associated with the substitute goods, and customers may have a preference for either your industry or the substitute industry, but buy-and-large, they meet a similar need.
- Different operations and inputs: While the customer need that is fulfilled may be similar, the manner in which substitutes achieve this is different. This is the key distinction between firms in your own industry and a substitute industry. The substitute industry may have a group of firms that operate in a completely different way – using different manufacturing processes, resources, technologies, or employee skills. Essentially the substitute industry has a way of broadly competing but achieving this in a different way.
The extent to which the substitute goods meet a similar need
While the products and services of a substitute industry may meet a similar customer need, the fact that they have achieved this in a different manner likely will mean that there are some differences between your products from the perspective of customers.
For example, we can think of room sharing industry (for example, AirB&B) and hotels as being substitutes to one another – they both areas provide the ability for customers to get a night accommodation, but while hotels actually manage the rooms and employee individuals to clean them, the likes of AirB&B are software companies, having developed a platform for rooms to be listed. While there are clearly similarities from the perspective of the customer, there is also some distinctions – the locations are often not downtown for AirB&B rentals (quite often in residential neighborhoods), and AirB&B and others lack the ability to provide such a consistent experience as hotels are able to achieve by managing their chains directly.
The differences between the underlying product or service thus may mean customers have a preference between one good over the other. The goods are in some ways linked to each other – if the price of one increases, customers will likely switch to the other – but still, there are specific reasons why some customers may opt to remain purchasing from one industry rather than the other. The extent of similarity will influence how directly you compete with the substitutes – if customers can barely tell the difference, and don’t have a strong preference for one product over the other, the greater competition that substitute industry will be.