Substitution Analysis

Substitution analysis examines those products that perform the same function or satisfy the same need as the given product of an industry. The purpose is to understand what products constrain the industry from raising prices by identifying:

• the relative value delivered and the price of the substitute when compared to the existing product
• the cost of switching to the substitute product
• the buyer’s tendency to switch between substitute products 

The wider the definition of need, the greater the number of potential substitutes:

Methodology

1. Define industry boundaries. Analyze companies offering a similar product range or via a market perspective based on common needs of customers.
2. Determine substitution threats. Assess value delivered by products’ relative cost, analyze buyers’ tendency to switch, and then assess the threat of substitution.
3. Assess market opportunities. Identify opportunities for company’s product in areas traditionally considered outside the market.

Notes

• A substitution threat analysis can identify the relative value of products, switching costs, and buyers’ tendency to switch products
• A substitution threat analysis can be used to promote or defend against substitution
• Focuses on all products competing for the customers, not just those similar to the client’s own products

Strengths

• Particularly useful where industries are going through radical changes
• Can be a helpful in redefining competition in value/cost terms

Weaknesses

• Not a science—some degree of ambiguity always remains
• Can be difficult to quantify the costs of promoting or defending against a substitute product