Understanding substitute products
Substitute products are products produced by a different industry that compete to some degree with products sold by your industry. They may not be a direct replacement for your products, for example, the product features may be slightly different, but substitute products may meet at least some of the needs that your customer shave.
What makes a substitute fall outside your industry
Substitute products are typically considered as products that while meeting a similar customer need, are created in a different manner to products in your industry. The product inputs – factors of production – are different, so while it may meet a similar need, it has achieved this in a different manner.
A simple example would be glasses and contact lenses – both meet a similar customer need, but do so in a different manner and are made using in completely different ways.
How close the substitute is to meeting the same customer need
Substitute products fall on a spectrum between those that are very close substitutes and those that are distant substitutes. Close substitutes are products that from the customer perspective are very similar to the products of your industry. Distant substitutes on the other hand may only tangentially compete.
The closer the substitute, the more directly customers will switch from your product to the substitute (or vice versa) if there is a price difference. Thus close substitutes are more of a direct threat than distant substitutes, where customers may be willing to pay a significant premium relative to the substitute because it is more in-line with their needs.