This is the second in a series related to the threat of substitutes based on research in the structural panels industry. Part I introduced core themes and the sector.
Why Substitute?
A consumer considers substituting one product or service for another if it (1) is cheaper; (2) has higher quality; or (3) offers more features or performance, while also having (4) sufficiently low “switching costs” (it’s easy to make the change).
Consider examples from home. We substitute our dish detergent for a cheaper one; we sometimes buy a “higher quality” craft beer instead of our normal one; and we trade in flip phones for higher performing iPhones. Meanwhile, it takes effort to switch utilities, schools and home insurance. In sum, cost, quality and performance, along with switching costs, intermingle when considering substitutes for purchases large or small.
When should substitutes concern executives and investors? In a commodity business, the question often comes down to whether or not a substitute product gets the job done at a lower net cost. The factors described inform the ultimate tradeoff between price and performance. And for forest products, substitutes can come from within or outside of the industry.
Lessons from Structural Panels on Substitutes and Substitution
Adding capacity in the structural panels industry requires significant capital investments. What do we observe from firms seeking to maximize and protect these investments from substitutes?
Lesson One: Controlling Costs Offers an Explicit First Line of Defense
Direct from the “competitive forces” playbook, low cost structures provide a strategy for dealing with substitute commodities. Efficiency, scale and anything that lowers per unit manufacturing or shipping costs strengthen competitiveness. This is why most forest products are consumed near where they are produced.
History supports this. Consider geographic substitutes within the industry. Plywood production from the Pacific Northwest increased following World War II. Then, during the 1960s, Georgia-Pacific built facilities that manufactured structural plywood from southern pine. The rapid growth and acceptance of southern pine plywood benefited from lower rail transportation costs, as these plants were closer to markets in the East and Lake States (Sinclair 1992).
On the manufacturing side, best-in-class production costs enhance the ability-to-pay for logs. The ability to source wood and remain cash positive through the economic cycle provides a strategic advantage, and cost control is part of this equation.
Clarity on costs and business tradeoffs also supports effective leadership. Executives and operating managers who demonstrate an intuitive understanding of their firms’ cost structures and improvement opportunities inspire confidence with investors, customers, and employees. I remember sitting in a meeting years ago with a sawmill manager in the Pacific Northwest who fielded questions from employees and union leadership. He addressed tough questions related to profits, wages and benefits by providing transparency into the economics of the business. He went to the chalkboard and said, “Here’s how things work.” He clarified tradeoffs. Did everyone like the answers? No. Did everyone understand how and why decisions were made? Yes.
Now, controlling costs, while necessary in a commodity business, is also insufficient when dealing with the threat of substitutes. We address this in Part III.
Leave a Reply