In the second of a weekly series, W. Chan Kim and Renée Mauborgne explain how companies can find opportunities for innovation by looking at substitute industries 

The airline industry is renowned as one of the world's most competitive. When one carrier cuts prices, the others follow. When another installs cappuccino bars in airport lounges, others imitate. The intensity of competition, coupled with high costs of maintenance, safety, crew, fuel and aircraft, makes consistent profitable growth a heroic achievement. 

Yet Southwest Airlines of the US side-stepped all of that. It made the competition irrelevant by creating a new market: short-haul air transport. Not only does Southwest always increase demand, often quadrupling or quintupling the number of passengers on the routes it flies, it has been consistently profitable for more than 25 years, a feat that has been accomplished by no other airline. 

The reasons for Southwest's success are well documented: it focuses on short-haul flights with an average distance of 425 miles. It does away with meals, in-flight films, designated seats, multiple seating classes from first to economy, membership in an airline reservation system, central airports, and a hub-and-spoke route system - all previously assumed to be indispensable to success. 

In their place Southwest created the concept of frequent point-to-point flights, with fares often 60 per cent below competitors', plastic reusable boarding passes, airports in small cities or smaller, less-congested airports in larger cities and 15-minute gate turnrounds (against 35 minutes for the average carrier). 

But where did Southwest find the insight to create this new market? How did it break out of the conventional wisdom that defined how airlines compete? 

The answers to these questions also explain how Home Depot gained the insight to create the Do-It-Yourself market in the US, and how Kinepolis, the Belgian cinema group, transformed European cinema with megaplexes. 

Instead of focusing on rivals within an industry, these companies moved across industries. But not just any industry; they moved across substitute industries. 

Southwest understood that for short-haul destinations, surface transport, namely the car, was a substitute for flying. By concentrating on the factors that lead people to choose one of these forms of transport over the other, and eliminating or reducing everything else, the imagination of Southwest was born. 

Consider people who choose flying over driving for short journeys. What is the key factor in their decision? Do people fly because they want multiple seating-classes, meals, in-flight films or designated seats? The answer is, quite simply, no. Fundamentally, there is only one factor that makes people choose flying over driving: speed. People fly to save time. 

Accordingly, Southwest created point-to-point flights to make short-haul travel even quicker and used secondary airports which cut an additional 15-25 per cent off average flight time (the result of reduced taxi time, fewer gate holds and less stacking in the air to land). 

To understand the rest of the Southwest formula, consider the flip side: why do some people choose the car over the aircraft for short journeys? Because it is cheap and you can leave when you choose. 

Hence, Southwest's innovation of frequent flights throughout the day and tickets priced not against other airlines but dramatically lower against surface transport. 

By focusing on the key discriminating factors of both flying and driving, and eliminating or reducing everything else, Southwest has inserted itself creatively between airlines and surface transport, thereby creating a new and highly profitable market. 

Like airlines, companies in most industries compete, in a broad sense, with other industries producing substitute products or services. In almost anything we do - whether we are institutional buyers, industrial buyers or individuals - we intuitively compare substitutes. 

Yet companies often forget this. From their point of view, substitutes operate in a distant and seemingly unrelated market. So airlines compete fiercely among themselves and benchmark one another's actions, as do carmakers. But neither industry pays much heed to the other. 

It is in the space between substitute industries that tremendous opportunities exist for creating new markets. The critical question is: what are the key factors that make buyers choose one substitute over another? The point is to look beyond the key factors rivals compete on within an industry and focus instead on the broad discriminating factors that lead buyers to move across substitute industries. 

When Home Depot applied this path to new market creation, it saw that for home improvement there were two substitutes: ironmongers and professional contractors. While people patronised ironmongers for low-cost items, they went to contractors for their know-how. 

Home Depot combined the low price of ironmongers with the expertise of professional contractors. It recruited sales staff with expert knowledge. and sponsored in-store clinics to teach customers skills. The result: neither ironmongers nor contractors could compete with Home Depot's breakthrough in value for money. In 20 years Home Depot has become a Dollars 24bn  business, creating 130,000 jobs in more than 660 stores. 

Similarly, Federal Express and United Parcel Service created a new market by delivering mail at the near speed of phone, and Intuit's Quicken recreated the personal finance software market by combining the low price and ease of use of doing calculations by pencil with the speed and accuracy of traditional personal finance software. 

Kinepolis combined the best of cinema - large screens and spectacular sound and pictures - with the best of watching videos at home on a VCR - comfy seats, wide choice, no hassles, no waiting for tickets and babysitting facilities - to create the 25 or 30-screen megaplex cinema. 

Is your company locked in competition with rivals in your industry? To break out of this, search for other products and services that can perform the same function as the products and services of your industry. If several substitutes are identified, focus on those with the greatest volume and value. Think of Southwest focusing on the car, but not buses, which are used by only a minority of Americans. 

Then ask: what are the key factors that lead buyers to choose one substitute over another? By concentrating on the strengths of both substitutes and eliminating or reducing everything else, your company too can be on the road to profitable growth. 

Next week: how Swatch, The Body Shop, Starbucks and Direct Line Insurance created new market space by shifting the appeal of their industry.