How many competitors do you think you have? Are you sure your environment isn’t more competitive than that? It is easy to underestimate how many competitors a company has. While finding out about direct competitors is easy, the threat of indirect competitors (or threat of substitutes) can be more difficult to evaluate. Ultimately, when does this competition matter, and when is it less of a problem? Let’s find out!
What are indirect competitors?
First, let’s define direct and indirect competition. Direct competitors are substitutes for your products with similar features that satisfy the same needs. Think of Coca-Cola and Pepsi, Nike and Adidas, or McDonald’s and Burger King. Most companies are obsessing over their direct competitors, for good reason. Direct competitors address similar customers and share many aspects of their business.
On the other hand, indirect competitors aren’t as obvious. Indirect competitors may have completely different features, price points, positioning, or distribution channels but fulfill the same needs. Let’s look at an example.
Coffee and energy drinks are two different products. They taste different and come in different packaging. Energy drinks are often stored in fridges or the beverage aisle, while coffee is served at coffee shops, gas stations, or in bags at the store. People go to a coffee shop to work or hang out with friends, but no one hangs out at gas stations to sip on Red Bull.
However, some people don’t care too much about the taste or social aspects. They only need their caffeine fix and must choose between several solutions, including a cup of coffee or an energy drink. In this case, energy drinks and coffee are indirect competitors; they share the “caffeine content” feature and cater to people trying to be less miserable in the morning.
Another example would be what is happening in the Ecommerce space. Online businesses are competing against one another, their direct competitors, but they also compete against brick-and-mortar stores offering the same product. As you know, customers might prefer driving to the store if they need the product soon or to save money.
When do indirect competitors matter?
At first, indirect competitors may appear a lot less threatening than direct competitors. If your product fulfills your customers’ exact needs, why would you worry about substitutes? While some substitutes are clearly inferior – partly because they were not designed with the same goals – others can be better than the original product.
Substitutes can offer better value
Uber is not another taxi company (and not directly competing with taxi companies if we take the term “direct competitor” in its strict sense). However, due to their strong value proposition, many customers consider their offer to be much better than what taxis can provide. A couple of years ago, before prices and fees increased, renting an apartment on Airbnb was much cheaper than getting a hotel room, most of the time. People enjoy the convenience of renting whole apartments that include a kitchen, which works better for larger groups. I’m sure many hotel managers started sweating when they found out about Airbnb becoming popular.
Substitutes can be cheaper
The substitute product doesn’t necessarily need to be better than the original product if its price is low enough compared to the original. Customers will almost always consider pricing when making their decision and can compromise on quality if they can save enough money. For example, a couple of years ago, several bus companies opened new lines in France. These lines competed with the much faster train company (when they weren’t on strike) but offered prices so low that customers who couldn’t afford a train ticket and had time for a longer trip started using these bus lines.
Switching costs can make substitutes less threatening
However, buying a substitute instead of the original product isn’t always the most convenient solution for the customer. When considering purchasing a different product, customers may face switching costs. Switching costs are the cost (monetary, time, or emotional) associated with switching from one product to an alternative and impact how threatening the substitutes are. The less difficult it is to switch to a newer alternative for the customer, the more threatening it is for the original business.
For example, unless it dramatically upsets your family, switching from a brand of ketchup to another has a very low associated switching cost. You buy another bottle from the store, bring it home, and you’re done. On the contrary, switching from an iPhone to an Android phone has a higher switching cost because you’ll need time to connect it to your other devices and get used to the very different user interface. Companies like to increase switching costs to prevent their customers from going to their competitors. Some might offer loyalty rewards, so customers don’t want to waste their loyalty points by buying from another company.
The threat of substitutes can vary
The threat of substitute products is difficult to evaluate. It sometimes varies based on several factors, such as seasonality and location. Ice cream is a substitute for cookies that people are more likely to buy during the warmer months. Likewise, snowboarding is a credible alternative to skateboarding in some northern states with ski resorts, but not so much in Florida. A good way to identify indirect competitors is to avoid thinking, “Who sells the same product as I do?” and think, “What needs does my product satisfy?” and then, “What other product on the market satisfies the same needs?” You may realize your product is competitive when put against its direct competitors, but not good enough/too expensive compared to substitutes.
Substitutes can be business opportunities
It is easy to understand why more and better substitutes can be a threat to an existing business. But, keep in mind that the reverse is true: coming up with a great substitute product can be a fantastic business opportunity. It may have the potential to create new demand while attracting customers who normally buy other products. For example, Uber is used by people who wouldn’t usually get a taxi while also attracting customers who often ride in taxis. Fast, casual restaurants (restaurants that do not offer full table service but offer higher-quality food, like Chipotle or Panera Bread) started as an alternative to low-quality fast-food while being faster and cheaper than traditional restaurants. There are thousands of examples, and I find studying these very exciting.
Not paying attention or not knowing about indirect competitors can be a critical mistake. It can lead to underestimating the competitive environment and not understanding customers’ behavior. That is why I think it is important to not only know who the competitors are but also what makes a substitute product threatening.