BUS206: Management Information Systems

Executives need to take stock not only of their direct competition but also of players in other industries that can steal their customers. Substitutes are offerings that differ from the goods and services provided by the competitors in an industry but that fill similar needs to what the industry offers . How strong of a threat substitutes are depends on how effective substitutes are in serving an industry's customers.

At first glance, it could appear that the satellite television business is a tranquil one because there are only two significant competitors – DIRECTV and DISH Network. These two industry giants, however, face a daunting challenge from substitutes. The closest substitute for satellite television is provided by cable television firms, such as Comcast and Charter Communications. DIRECTV and DISH Network also need to be wary of streaming video services, such as Netflix, and video rental services, such as Redbox. The availability of viable substitutes places stringent limits on what DIRECTV and DISH Network can charge for their services. If the satellite television firms raise their prices, customers will be tempted to obtain video programs from alternative sources. This limits the profit potential of the satellite television business.

In other settings, viable substitutes are not available, and this helps an industry's competitors enjoy profits. Like lightbulbs, candles can provide lighting within a home. Few consumers, however, would be willing to use candles instead of lightbulbs. Candles simply do not provide as much light as lightbulbs. Also, the risk of starting a fire when using candles is far greater than the fire risk of using lightbulbs. Because candles are a poor substitute, lightbulb makers such as General Electric and Siemens do not need to fear candle makers stealing their customers and undermining their profits.

The dividing line between which firms are competitors and which firms offer substitutes is a challenging issue for executives. Most observers would agree that, from Subway's perspective, sandwich maker Quiznos should be considered a competitor and that grocery stores such as Kroger offer a substitute for Subway's offerings. But what about full-service restaurants, such as Ruth's Chris Steak House, and "fast causal" outlets, such as Panera Bread? Whether firms such as these are considered competitors or substitutes depends on how the industry is defined. Under a broad definition – Subway competes in the restaurant business – Ruth's Chris and Panera should be considered competitors. Under a narrower definition – Subway competes in the sandwich business – Panera is a competitor and Ruth's Chris is a substitute. Under a very narrow definition – Subway competes in the sub sandwich business – both Ruth's Chris and Panera provide substitute offerings. Thus clearly defining a firm's industry is an important step for executives who are performing a five forces analysis.