Which are the main factors which influence the threat of substitute products?

Substitute Products Definition

A substitute product refers to any alternative, replacement, or backup of primary goods in the market. In other words, it relates to any artifact, commodity, or combination of goods that in normal circumstances would act as a replacement or alternative of a more popular item without noticeably affecting the composition or appearance, or usefulness of the resulting product.

Factors Affect Demand for Substitute Products

You are free to use this image on your website, templates, etc., Please provide us with an attribution linkArticle Link to be Hyperlinked
For eg:
Source: Substitute Products (wallstreetmojo.com)

1. Price: The price of popular products understandably plays an important role in determining the demand for substitute products. Primarily, if substitutes are priced higher than the basic item, the demand for substitutes tends to decrease. As per the age-old law of economics, there is an inverse and intuitive relation between price and demand.
2. Shifting Cost: Shifting cost refers to the additional cost of production that would have to be incurred for moving from primary good to a substitute good. If this cost is high, the demand for substitutes will decrease, and vice versa.
3. Quality: If substitutes provide better quality (even at a high cost), the consumer tends to shift from the basic product to the replacement. Thus, resulting in increased demands for substitutes in the economyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more.
4. Availability: If substitutes are more than the primary product and easily accessible to the end-user, then the demand for substitutes increases compared to the basic product and vice versa.

Examples

Some major examples are as follows:

You are free to use this image on your website, templates, etc., Please provide us with an attribution linkArticle Link to be Hyperlinked
For eg:
Source: Substitute Products (wallstreetmojo.com)

#1 – Coca-Cola and Pepsi

Undoubtedly, the best example of substituted products is the biggest rivalry of the 19th century – Coke and Pepsi. However, if the available factors are distorted, like availability or price, demand shifts.

Consider the diagram below, which shows the economic possibility that when the price of Coke increases, there is a shift in the quantity consumed. This decrease in quantity is substituted by Pepsi’s corresponding increase in its substitute product.

#2 – Mc Donald’s and Burger King

Both these products are famous burger giants popular across the planet. Although both the products are different in terms of market shareMarket share determines the company's contribution in percentage to the total revenue generated within an industry or market in a certain period. It depicts the company's market position when compared to that of its competitors.read more, they are consumed interchangeably by the consumers. Effectively, it means that the consumer prefers the other without one.

The risk of Substitute Products

1. Distinctive Nature: The primary good might be offering some unique features or additional benefits along with the product, which is difficult for a substitute to replace. It can be hidden or evident in effect.
2. Value: If the substitute is available for less or more or less of the same value as the basic product, it acts as a threat to the primary commodityA commodity refers to a good convertible into another product or service of more value through trade and commerce activities. It serves as an input or raw material for the manufacturing and production units.read more. If the substitute is available for a higher value than the primary product, it becomes a risk for a substitute because it becomes difficult to penetrate the marketMarket penetration is calculated as how much the customers are using the product or service compared to the total market for that product or service.read more.
3. Brand Conscience: It is difficult to target the brand’s loyal customers.

Impact

The impact of substitutes is explained in macroeconomicsMacroeconomics aims at studying aspects and phenomena important to the national economy and world economy at large like GDP, inflation, fiscal policies, monetary policies, unemployment rates.read more. All these are governed by the concepts of demand and supply and their relationships with price and costs. The implications of substitutes are both on the market and producers. The consumer population comprises various consumers with different moods, tastes, requirements, and demands. Therefore, if more substitutes exist in the market, each producer’s share reduces because more brands target the same population. Furthermore, the market becomes cost-sensitive if there are many substitutes available. As a result, the consumer population tends to shift brands, even for minor price changes. Due to these factors, companies try to discover various innovative techniques to reduce the costs of products to maintain market share. In many cases, one of these techniques is compromising quality to lower prices. On the other hand, if there are fewer substitutes, the situation turns favorable for the producer, and there are chances of creating a monopoly.

Advantages

• Variety: There will be a variety in the market for end-users to choose the best product per their fulfilling needs. Type helps the end-users judge the product better, allowing companies for better product developments.
• Competition: Substitutes are a reason for a healthy market fight among product competitors, which results in the best product quality for consumers. Thus, benefiting the consumers, avoiding monopoly in the market, and justifying the phrase “Customer is a king.”
• Price: Substitutes indirectly control the costs because customers would conduct a  cost-benefit analysisCost-benefit analysis is the technique used by the companies to arrive at a critical decision after working out the potential returns of a particular action and considering its overall costs. Some of these models include Net Present Value, Benefit-Cost Ratio etc.read more before purchasing a product. The competitors tend to maintain prices to increase sales and not lose them to substitutes.

Disadvantages

• Quality: In places where the customer population is cost-conscious and ready to compromise on quality for relatively cheaper products, it is difficult to retain customers because even for minute price variations, a consumer may move to substitute goods, thus making it difficult for primary goods producers.
• Availability: In cases where the availability of substitutes is quite convenient compared to primary items, it is difficult for the market of primary goods to survive.
• High Marketing Costs: For retaining customers, the corporates may incur high investmentsInvestments are typically assets bought at present with the expectation of higher returns in the future. Its consumption is foregone now for benefits that investors can reap from it later.read more in the marketing of the product. These costs are incurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. read more to attract more and more customers and capture the maximum possible market available for the product. That, in turn, leads to an overall increase in the cost of the product without giving any additional value to the product.

Conclusion

Substitutes are the reason which motivates corporates for continuous product developments to bring out unique variants in the market with better quality and standards but at reasonable prices, thus providing better customer satisfaction.

Recommended Articles

This article is a guide to Substitute Products. We discussed the substitute products example, risks, impact, factors, advantages, and disadvantages. You may learn more about financing from the following articles: –

• Price Fixing
• Complementary Goods
• Prestige Pricing
• Determinants of Demand