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iii)                Substitution products

Substitution products are those products your customers could purchase as substitutes for the products that your company is selling. Of course, this is bad news for your business, because this means that you are losing sales while your competitors are winning them over (assuming that substitution products are produced by the competition; the case where your firm is actually producing both a product and one of its possible substitutes will be treated below). Identifying what are the potential substitution products is therefore important in order for you to check where your lost sales are going and how the market would be changing in case of sudden economic changes.

Why are economic changes relevant to this context ? They lie at the center of our discussion because a lower purchasing power, for instance, will drive consumers to purchase lower price products that will achieve functions equivalent with that of the initial more expensive product: for instance, if the cost of oil is rising, then people will prefer to go to work with a bike (whenever their workplace is not too far from their residence, that is). In this case, bikes will be accounted for as substitution products for cars.

Another key notion when talking about substitution products is that of cannibalization of sales.  Cannibalization occurs whenever a new product sold by your company is actually stealing market shares from another (older) product which could be considered as a substitute and which is also sold by your firm. A consequence of cannibalization may be substantial losses, for instance due to the fact that the marketing costs incurred to sell the new product will actually result in fewer sales of the older product, thus destroying value.

Example:  a Starbucks franchise may cannibalize sales from another Starbucks franchise a few blocks down the street.