Threat of new entrants

From CEOpedia | Management online

Threat of new entrants is one of five aspect (force) of Five forces analysis. It is a method of strategic analysis and assessing the intensity of competitive forces in the economic sector, developed by Michael E. Porter in 1979. Porter's Five forces analysis should be part of every business plan. The analysis is recommended to be carried out for new created company before entering the market because thanks to the estimation of five factors related to the company's environment and shaping competition on the market, it gives an assessment of the attractiveness of the sector, helps to understand the structure of the sector and it will defines what strategic position to take to increase profits and reduce the tendency to attack from the outside. Analysis is a helpful tool for existing companies to consider a new venture or assess its strategic position. Investors can also use it to estimate the company's development prospects which they are interested.

Five forces shaping competition in Porter's analysis are (T. Grundy 2006, p. 214):

Factors that increase the threat of new entrants

The following factors may increase the threat of new entrants:

Threat of new entrants applies to all companies that can enter a given market, both existing ones and those that are just being created. Their striving to gain market share determines the level of prices, costs and investments necessary to continue to compete. The mere threat and not the actual appearance of new participants limits the amount of potential profits in the industry. When the probability of this threat is highly real, companies with an established market position to discourage new players use the tactics of lowering prices and increasing investment outlays.

Threat of new entrants depends on existing entry barriers and on the response to such situation of companies already present on the market. The lower the entry barriers and the new participants can expect little retaliation, the risk of increasing the number of players on the market increases and the profitability of the industry is moderate. Entry barriers are defined as the advantage that current players have in relation to newly entering companies (M.E. Porter 2008, p. 26). The risk of new entries for a given market is inversely proportional to entry barriers and directly proportional to the profitability of a given market.

The factors affecting entry barriers

The factors affecting entry barriers (M.E. Porter 1979, p. 138-140):

  • Capital intensity - The higher the capital requirements of business, the lower the threat of entering new entrants.
  • Economies of scale - The threat of new entries is lower when existing companies gain significant economies of scale.
  • Know-how - Acquisition of specialist knowledge is a long-term process, sometimes difficult and expensive, and can constitute a significant restriction of market entry for new competitors.
  • The cost of changing supplier by the customer - The threat of new entries is higher when it's easier fot the customer to change suppliers.
  • Differentiation of products among competitors - The barriers to entry are higher when the products offered are varied and have features that allow the customer to associate them with a specific brand.
  • Legal barriers - Government policy can hinder new entry because of licensing requirements, restrictions on foreign investment, patenting rules, environmental or safety regulations and make it easier through subsidies or funding basic research. It's typical in that industries like: liquor retailing, taxi services or airlines.

Examples of Threat of new entrants

  • High capital requirements: It is costly to enter a market as it involves significant investments in research, development, production and marketing.
  • Economies of scale: Large companies with well established production processes can produce goods and services at a lower cost than smaller companies.
  • Incumbent advantages: Incumbent companies have advantages such as financial resources and well established customer relationships.
  • Technology barrier: A company entering a market needs to have advanced technology, which can be difficult to acquire.
  • Access to distribution channels: It can be difficult for a new entrant to gain access to existing distribution channels.
  • Government regulation and policy: Government policies can limit new entrants from entering a certain market.
  • Brand loyalty: Consumers may be loyal to certain brands, making it difficult for a new entrant to break into that market.

Advantages of Threat of new entrants

One advantage of the threat of new entrants is that it can help existing companies to identify areas where they may need to improve their competitive position. Here are some other advantages of threat of new entrants:

  • It can help create a competitive environment, motivating companies to innovate and improve their products and services.
  • It can help protect the market from excessive concentration of power, allowing for competition and diversity of choice for consumers.
  • It can help create a dynamic environment that keeps prices competitive and helps prevent companies from becoming complacent.
  • It can provide an incentive for existing companies to invest in research and development, in order to create new products and services that will differentiate them from their competitors.
  • It can open new markets and opportunities for existing companies to expand and grow their business.

Limitations of Threat of new entrants

  • Porters Five forces analysis is a useful tool but it has some limitations. The threat of new entrants is one of the five forces analysis, however, its effectiveness is limited as it does not take into account the effects of innovation, government regulations and subsidies, customer loyalty and the power of existing competitors.
  • The threat of new entrants does not consider the existing barriers to entry for the new entrants such as the cost of capital, economies of scale, the cost of technology, existing brand loyalty and the availability of resources.
  • The threat of new entrants does not consider the presence of other substitutes to the product or service being offered by the new entrants. This means that the new entrants may face stiff competition from existing substitutes and may not be successful in their venture.
  • Lastly, the threat of new entrants does not take into account the impact of the external environment on the new entrants. Political and economic factors can have a major effect on the success or failure of the new entrants and should be taken into consideration when evaluating the threat of new entrants.

Other approaches related to Threat of new entrants

One way to evaluate the Threat of new entrants is to consider other approaches related to this factor. These include:

  • Analyzing the current competitive landscape: Examining the current competition and how competitive the market is can give insight into the potential threat of new entrants. This involves looking at the competitive dynamics and the structure of the market to identify any barriers to entry that could prevent new entrants from entering the market.
  • Analyzing the barriers to entry: Barriers to entry can include high capital requirements, government regulations, product differentiation, economies of scale and switching costs. By understanding these barriers, businesses can gain insight into how easy it is for new entrants to enter the market.
  • Examining the industry’s cost structure: Examining the industry’s cost structure can help to determine the potential for new entrants to enter the market. Costs such as economies of scale, economies of scope and economies of technology can hinder the ability for new entrants to enter the market.
  • Evaluating the customer’s bargaining power: Evaluating the customer’s bargaining power can help to understand the potential threat of new entrants. If customers have a high degree of bargaining power, then new entrants may have difficulty competing with incumbents.

In summary, the Threat of new entrants can be evaluated by analyzing the competitive landscape, barriers to entry, cost structure and customer bargaining power. These approaches can help businesses understand the potential for new entrants to enter the market.

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Author: Anna Gołdyn