Barriers to entry

According to Bain, the barrier to entry is a long-run condition that allows firms already existing in a certain market to make a profit above their average costs, without being attracted by firms outside . Over the years, various economists have developed theories, ideas and definitions regarding the concept of the barrier to entry. The first to advance the concept was Bain, in 1956. According to more modern ideas, on the other hand, the barrier to entry is seen as an instrument to hinder competition in a market, because in one way or another one wants to make it difficult for certain companies to enter. Being within a certain market can be seen as a competitive advantage, an idea later developed by Porter, who also focuses his studies on this.

Porter's idea

Porter proposed the following six barriers to market entry: cost advantages of incumbents, product differentiation of incumbents, capital requirements, switching costs of customers, access to distribution channels and government policies. As Porter, first and foremost, and then many authors to come argue, barriers obviously differ in importance and above all do not have the same value by whom they are perceived. Therefore, it is possible to first make a difference in the market where these barriers are applied or perceived . The book under consideration focuses on two different markets, that of consumer goods and that of industrial goods. In fact, the author argues that cost advantages, customer switching costs, and political barriers are more critical barriers when considering entry into the industrial goods market, rather than the consumer market. And vice versa with other barriers . It tends to be the case that when and if a sector has a much higher return on capital than its production costs, in the short and long term it will attract entry from many other companies who, of course, notice the positive return. Now imagine the case where, barriers to entry were not there. The market will probably no longer be profitable, because so many companies will enter the business, and competition will grow out of all proportion. There are some sectors where it is very easy to create new businesses, in the consumer market, however, the beer market is an example. According to one statistic, breweries in the United States have increased from 285 to 4250, in about 30 years . Obviously, this is to justify that markets where there are no barriers to entry exist, but of course prices are competitive, by definition, regardless of the number of companies present. In the markets studied by Porter, however, firms have to overcome obstacles, which we will conventionally call barriers to entry, in order to enter.

Origins of Barrier to Entry

In the following, the origins of these barriers to entry will be explained.

• Capital requirements

In certain situations, start-up costs are required to enter a market. Depending on the weight, they may or may not discourage companies that want to enter a market. An example is the telephony market, with a modest technological cost. Because of this, competition is very high and there are many players in the market .

• Economies of scale

The problem of economies of scale is discussed by many authors, especially when they are new entrants, as in our case. Indeed, the high costs that are devoted to distribution or marketing have to be amortised by large volumes of production quantities, which are not always obvious for a new entrant. This is because the production technology may not be suitable for large volumes. An example of this is the automotive market. Here, large production quantities are required to amortise and optimise costs incurred .

• Absolute cost advantages

Regardless of the economies of scale, all companies within a market can boast an advantage over new entrants: cost. Often this advantage comes from having low-cost raw materials, even if during the writing period of the article, in 2022, it is not the best example to give, as there is a dearth of all natural resources, due to a serious social situation. However, the cost advantage can also derive from experience in the field, useful for optimizing costs .

• Product differentiation

This barrier is one of the most difficult to overcome, this is because product differentiation refers to brand loyalty on the part of the consumer, who obviously already knows the product he is going to buy. Here the barrier refers to the cost that is required to make its brand, of the company that wants to enter the market, equal to the others .

• Access to distribution channels

To access the distribution channels that a market offers, it takes time, time to build relationships even within the market that can make distribution or internal information easier. This represents one of the main barriers for businesses. Because sometimes distribution represents a great cost for companies, especially for new ones. The Internet, actually, proved to be of help in this, because thanks to its network, it gave the possibility of easy access to distribution channels .

• Government and legal barriers

One of the most powerful barriers to entry are those imposed by the relevant government. In fact, in some cases the governments under consideration make access difficult because, for example, they have imposed some taxes to access, therefore costs for businesses, or specific legislation for intellectual property, or request for some specific certifications, as in the case of medical devices .

• Retaliation

In a market it is difficult to play in a fair way, and this may be the case. In fact, companies already present in the market, to discourage the new entrant, could exponentially reduce their prices and attack consumers with powerful advertisements, thus promoting sales as never before. Most of the time, the incoming companies, to avoid this barrier, aim to attack almost abandoned market segments so that in this way they can produce on a small scale and slowly make their brand known .

• The effectiveness of the barriers to entry

The question to ask at this moment is "How efficient are the barriers to entry?". The answer can be found by looking at the competitiveness of companies already present in the market, how competent they are and how much the big companies can act as points of reference or not. Because if there is a big one, this can represent a threat, a barrier to entry, or not .

Author: Samuele Cannistrà

References

• Grant M.R., (2018), Contemporary Strategy Analysis, Wiley, Tenth Edition.
• Karakaya F., Stahl M.J., (1989), Barriers to Entry and Market Entry Decisions in Consumer and Industrial Goods Markets, Journal of Marketing, Vol. 53, No. 2.
• Preston McAfee R., Mialon H. M. , Williams A. M., (2004), What Is a Barrier to Entry?, American Economic Association, Vol. 94, No. 2.