You may want to launch a new product, start a new business or enter a new market. What’s stopping you?
BARRIERS to entry are the obstacles that must be overcome and the costs that must be paid by a new entrant but not by firms already in the industry. Barriers to entry have the effect of making a market less contestable and allow existing firms to maintain higher prices than would otherwise be possible.
Here are 8 examples of barriers to entry:
1. Capital requirements
High start-up costs: High fixed start-up costs will deter new firms from entering an industry. Examples of capital intensive industries with high fixed costs include the automotive and telecommunications industries.
High sunk costs: If a large portion of the start-up costs cannot be recovered (i.e. they are sunk costs) then the new entrant risks having to absorb the loss if it decides to exit the industry. Examples of sunk costs include:
- Specialised assets: Highly specialised technology or equipment that cannot be used for other purposes and which cannot be sold (or can only be sold at a massive discount).
- Industry specific expenditure: Industry specific expenditure, such as marketing or R&D, which cannot be used to benefit the firm’s operations in other industries.
2. Intangible assets
Proprietary product technology: The existence of proprietary product technology represent a barrier to entry. If an existing product is protected by patent then it will not be possible for a new entrant to use the patented technology without permission from the patent owner.
Brand recognition: If existing firms and products have strong brand recognition that will deter new entrants. If customers perceive existing products as unique or high quality then a new entrant will need to spend money to educate customers about about the unique qualities and benefits of its new products. This will increase the cost of gaining market share and deter entry into the market.
Specialised knowledge: Some industries require specialised knowledge, skill or qualifications: e.g. law or medicine.
Customer relationships: If existing firms have strong customer relationships it may be difficult for new entrants to gain market share.
3. Access to raw materials
If a new entrant cannot gain access to raw materials then this represents a barrier to entry. If existing firms have exclusive long term contracts with suppliers (or existing firms own key suppliers) this will make it difficult for a new entrant to obtain the raw materials it needs to operate effectively in the industry.
4. Access to distribution channels
If existing firms have exclusive long term contracts with distributors this will make it difficult for a new entrant to reach the customer.
5. Economies of scale
The existence of economies of scale in an industry creates barriers to entry. Existing firms are usually in a better position to exploit economies of scale than a new entrant and, as such, may be able to force a new entrant out of the market by undercutting on price.
6. Network effects
The term “network effect” refers to the situation where a product or service becomes more valuable as more people use it. One product that experiences positive network effects is the telephone; the telephone becomes more valuable to each user as more people own one. Another example is eBay; as more buyers use the online auction site it becomes more valuable to each seller, and as more sellers use the site it becomes more valuable to each buyer.
If existing products or services in the industry benefit from network effects then it may be difficult for new firms to enter the industry.
7. Government regulation
Regulated markets: The government may restrict entry into a market, or make competition illegal by establishing a statutory monopoly. For example, AT&T had a statutory monopoly in the telecommunications industry in the United States until the early 1980’s.
Trade restrictions: Trade restrictions represent a barrier to entry. For example, import tariffs will deter foreign firms from entering the domestic market.
Licenses and permits: If government approval is required before a firm can do business then this will deter entry into the industry. Examples of government approvals that may be required include taxi licenses, safety standards compliance certificates, mining permits, or investment approvals.
8. Competitive response
It is important to consider how existing firms might respond to a new entrant. If we expect existing firms to respond by aggressively lowering prices then this will deter new firms from entering the industry.