The notion of ‘directly competitive or substitutable products’, similar to ‘likeness’, raises considerable interpretation difficulties. There is neither systematic definition nor guidance to determinate the term. In the Japan-Taxes on Alcohol II case, the Appellate Body held that the specification of directly competitive or substitutable products must be made on a case-by-case basis taking into account all the relevant facts.
It is important first to note that the notion of ‘directly competitive or substitutable products’ is broader than the category ‘like products’ in Article III:2, first sentence. In effect, ‘all like products are, by definition, directly competitive or substitutable products, whereas not all directly competitive or substitutable products are like’. In addition, in the of Canada – Periodicals case, the Appellate Body state that products must not to be perfectly substitutable in order to be ‘directly competitive or substitutable’, because a case of ‘perfect substitutability’ falls only under Article III:2, first sentence. This imperfect substitutability is a sufficiently strong relationship for the broader prohibition of the second sentence.
In the Japan-Taxes on Alcohol II case, the Panel emphasized the need to look not only at such matters as physical characteristics, common end-uses, and tariff classifications, but also at the ‘marketplace’, which constitutes the relevant criterion since what was at issue was the responsiveness of consumers to the various products offered in the market.
In the Korea – Alcoholic Beverages case the criteria of directly competitive or substitutable products’ played a crucial role. First, the Appellate Body confirmed that by determination of the term it is important to take into consideration the ‘marketplace’ factors. For this standard, the question of substitutability from the consumers’ perspectives is given considerably more weight than the factors of physical characteristics and tariff classifications.
Such interpretation of the criteria evoked a considerable discussion in the literature since the national treatment obligation finally reaches even those product relationships, in which the two products can share absolutely no physical similarity with each other, as long as they appeal to the consumers as ‘directly competitive or substitutable’.
The Appellate Body considered that the products fall under the definition if they are interchangeable or if they offer alternative ways of satisfying a particular need or taste. Furthermore, the Appellate Body held that when analysing whether products in question are ‘directly competitive or substitutable’, an analysis of latent as well as extant demand is required, because ‘competition in the market place is a dynamic, evolving process’ and therefore consumer behaviour could be influenced by protectionist internal taxation.
To establish ‘directly competitive or substitutable products’ the Appellate Body proposed as well an examination of the cross-price elasticity of demand in that market. Cross-price elasticity analysis assumes to predict the change in demand that would result from a change in the price of a product following from a change in the relative tax burdens on domestic and imported products. Both criteria ‘present direct competition’ and ‘a strong potentially direct competitive relationship’ are significant to determinate the likeness standard under Art III:2 second sentence.
As a consequence to show whether two products are directly competitive or substitutable, the WTO Panel and Appellate Body can look at factors like cross-price elasticity, elasticity of substitution, end-uses, consumers’ tastes and habits, and the products’ properties and nature. The list of relevant criteria is not exhaustive and other factors might be added.
This approach has meet considerable critic in the doctrine. Many commentators argue that consumer perceptions of differences between products cannot be dismissed just because they are created through advertising, even if the products at hand are physically identical, because there will be no protective effect of lower taxation of domestic products if consumers, for whatever reason, do not see a product as similar.
 Appellate Body Report, Korea – Alcoholic Beverages, para. 118.
 Appellate Body Report, Canada – Periodicals, p. 28.
 Appellate Body Report, Japan – Alcoholic Beverages II, p.24
 Diebold N. F., Non-Discrimination in International Trade in Services, ‘Likeness’ in WTO/GATS,p. 108
 Choi W.-M.,‘Like Products’ in International Trade Law: Towards a Consistent GATT/WTO Jurisprudence p. 109.
 Appellate Body Report, Korea – Alcoholic Beverages, para. 114-116.
 Ibid. para. 120.
 Ibid. para. 137.
 Horn H., Mavroidis P.C., Still hazy after all these years: the interpretation of national treatment in the GATT/WTO case law on tax discrimination, p. 45