Threat of Substitutes

The next environmental threat we will take a look at is the threat of substitutes. A substitute is a product or service provided by a firm’s rivals that meets approximately the same customer needs in the same ways as the product or service provided by the firm itself. In our analysis of the music and records industry the main product of focus is the compact disc or CD. In 2007, roughly 83 percent of sales for the music recording industry came in the form of full-length CDs. Check out the 2007 RIAA (Recording Industry Association of America) Consumer Profile. This number was down from a high of approximately 91 percent in 2002. Therefore, the vast majority of record company sales and revenues come from CDs. So from the point of view of the large music groups, the biggest threat of substitutes comes from alternatives to CDs, in which there are plenty.

The main purpose of a CD is to provide consumers with the power to listen to a particular artist or type of music whenever they want. Many other products including mp3s, cassettes, DVDs, among other things meet the needs of users in the same way at a lower cost. Typically, if you buy a full length CD at the music store or somewhere legally online you will pay between of $10 to $20. Now, however, with the increasing demand and access to digital file-sharing online and the various downloadable formats, consumers can obtain and listen to whatever type of music they like at a much lower and sometimes even for free. If you own a computer, all of this music downloading is done right in your own home, and is much more convenient then heading to the store. For this reason, it is safe to say there are many more attractive alternatives than using traditional CDs.

Substitutes to CDs like mp3s and other downloadable formats place a ceiling on prices firms in the music industry can charge and on the profits those firms can make. In the extreme, substitutes can ultimately replace an industry’s products and services if they are thought to be superior. This remains a big question in the music recording industry, as to what extent online downloading of music will replace compact discs. Since music groups and labels have to charge less for their CDs, revenues for the company go down and this causes profits to decline in turn. One could even argue that total costs rise since these companies have to spend more money creating alternative and cheaper forms of music in addition to CDs. Also, since competition is tougher, advertising costs may be higher for companies who try to distinguish their products. Ultimately, the threat of substitutes is high and the industry experiences increased costs, decreased revenues, and therefore, decreased profits. The diagram above to the right summarizes the threat of substitutes on the music industry, taking into consideration revenues, costs, and profits.

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