Substitute Products Definition
Substitute product refers to any alternative, replacement or back up of primary product in the market. In other words, it refers to any artifact, commodity, or combination of goods that in normal circumstances would act as 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
- Price: The Price of popular products understandably plays an important role in determining the demand for substitute products. Primarily because if substitutes are priced at higher levels as compared to the basic item, then 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.
- Shifting Cost: Shifting cost refers to the additional cost of production that would have to be incurred for shifting from primary good to a substitute good. If this cost is high, then understandably, the demand for substitutes will decrease, and vice versa.
- Quality: If substitutes provide better quality (even maybe at a high cost), then also the consumer tends to shift from the basic product to the substitute, thus resulting in increased demands for substitutes in the economy.
- Availability: If the presence of substitutes is more than the primary product and is easily accessible to the end-user, then the demand for substitutes increases as compared to the basic product and vice versa.
Some major examples are as follows:
#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, then there is a shift in demand.
Consider the diagram below, which shows the economic possibility when the price of coke increases, then there is a shift in the quantity consumed. This decrease in quantity is substituted by the corresponding increase in the quantity consumption of its substitute product – Pepsi.
#2 – Mc Donald 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 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., they are consumed interchangeably by the consumers. Effectively this means that in the absence of the one, the consumer has a preference for the other.
The risk for Substitute Products
- Distinctive Nature: The primary good might be offering some distinctive features of additional benefits along with the product, which is difficult for a substitute to replace. This can be hidden or evident in the product.
- Value: If the substitute is available for less or more or less of the same value as of the basic product, it acts as a threat to the primary product, whereas if the substitute is available for a higher value than the primary product, then this becomes a risk for a substitute because it becomes difficult to penetrate in the marketPenetrate In The MarketMarket penetration is calculated as how much the product or service is being used compared to its total market and how it creates a position in the market, especially in the primary stages of setting up the business..
- Brand Conscience: It is difficult to target loyal customers of the brand.
The impact of substitutes is explained in macroeconomics. All these are governed by the concepts of demand and supply, along with their relationships with price and costs. The impact of substitutes is both on the market and producers. The consumer population comprises a wide variety of consumers with different moods, tastes, requirements, and demands; therefore, if there are more substitutes in the market, the share of each producer reduces because more brands are targeting the same population. Furthermore, the market becomes cost-sensitive if there are many substitutes available. The consumer population develops a tendency of shifting brands, even for negligible changes in prices. Due to these factors, companies try to discover various innovative techniques to reduce the prices of products in order to maintain market share. In many cases, one of these techniques is compromising on quality to reduce 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.
- Variety: There will be a variety in the market for end-users from which they can choose the best product as per their satisfying needs. Variety helps the end-users in judging the product in a better way, which in turn helps companies for better product developments
- Competition: Substitutes are a reason for a healthy market fight among product competitors, which in turn results in the best product quality for consumers, thus benefiting the consumers and avoiding monopoly in the market and justifying the phrase “Customer is King.”
- Price: Substitutes indirectly control the costs because any customer would do a cost-benefit analysisCost-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. before purchasing a product, so the competitors tend to maintain prices for an increase in sales and not to lose it to substitutes.
- Quality: In places where the customer population is cost-conscious and ready to compromise on quality for relative cheaper products, it 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 as compared to primary items, then it is difficult for the market of primary goods to survive.
- High Marketing Costs: The corporates, in order to retain customers, may incur high investments in the marketing of the product. These costs are incurredCosts 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. to attract more and more customers and capture the maximum possible market that is available for the product. This, in turn, leads to an overall increase in the cost of the product without giving any additional value to the product.
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.
This has been a guide to Substitute Products and its definition. Here we discuss its examples, risk, impact, and factors that affect the demand of such products along with advantages and disadvantages. You may learn more about financing from the following articles –