Question

Discuss the major barriers to entry into an industry. Explain how each barrier can foster either monoply or ogigopoly.

Answer 1

Barriers to market entry include a number of different factors that restrict the ability of new competitors to enter and begin operating in a givenindustry. For example, an industry may require new entrants to make large investments in capital equipment, or existing firms may have earned strongcustomer loyalties that may be difficult for new entrants to overcome. The ease of entry into an industry in just one aspect of an industry analysis; theothers include the power held by suppliers and buyers, the existing competitors and the nature of competition, and the degree to which similar products orservices can act as substitutes for those provided by the industry. It is important for small business owners to understand all of these critical industryfactors in order to compete effectively and make good strategic decisions.

"Understanding your industry and anticipating its future trends and directions gives you the knowledge you need to react and control your portion of thatindustry," Kenneth J. Cook explained in his book The AMA Complete Guide to Strategic Planning for Small Business. "Since both you and your competitors arein the same industry, the key is in finding the differing abilities between you and the competition in dealing with the industry forces that impact you. Ifyou can identify abilities you have that are superior to competitors, you can use that ability to establish a competitive advantage."

The ease of entry into an industry is important because it determines the likelihood that a company will face new competitors. In industries that are easyto enter, sources of competitive advantage tend to wane quickly. On the other hand, in industries that are difficult to enter, sources of competitiveadvantage last longer, and firms also tend to develop greater operational efficiencies because of the pressure of competition. The ease of entry into anindustry depends upon two factors: the reaction of existing competitors to new entrants; and the barriers to market entry that prevail in the industry.Existing competitors are most likely to react strongly against new entrants when there is a history of such behavior, when the competitors have investedsubstantial resources in the industry, and when the industry is characterized by slow growth.

In his landmark book Competitive Strategy: Techniques for Analyzing Industries and Competitors, Michael E. Porter identified six major sources of barriersto market entry:

1. Economies of scale. Economies of scale occur when the unit cost of a product declines as production volume increases. When existing competitors in anindustry have achieved economies of scale, it acts as a barrier by forcing new entrants to either compete on a large scale or accept a cost disadvantage inorder to compete on a small scale. There are also a number of other cost advantages held by existing competitors that act as barriers to market entry whenthey cannot be duplicated by new entrants—such as proprietary technology, favorable locations, government subsidies, good access to raw materials, andexperience and learning curves.
2. Product differentiation. In many markets and industries, established competitors have gained customer loyalty and brand identification through theirlong-standing advertising and customer service efforts. This creates a barrier to market entry by forcing new entrants to spend time and money todifferentiate their products in the marketplace and overcome these loyalties.
3. Capital requirements. Another type of barrier to market entry occurs when new entrants are required to invest large financial resources in order tocompete in an industry. For example, certain industries may require capital investments in inventories or production facilities. Capital requirements forma particularly strong barrier when the capital is required for risky investments like research and development.
4. Switching costs. A switching cost refers to a one-time cost that is incurred by a buyer as a result of switching from one supplier's product toanother's. Some examples of switching costs include retraining employees, purchasing support equipment, enlisting technical assistance, and redesigningproducts. High switching costs form an effective entry barrier by forcing new entrants to provide potential customers with incentives to adopt theirproducts.
5. Access to channels of distribution. In many industries, established competitors control the logical channels of distribution through long-standingrelationships. In order to persuade distribution channels to accept a new product, new entrants often must provide incentives in the form of pricediscounts, promotions, and cooperative advertising. Such expenditures act as a barrier by reducing the profitability of new entrants.
6. Government policy. Government policies can limit or prevent new competitors from entering industries through licensing requirements, limits on access toraw materials, pollution standards, product testing regulations, etc.

It is important to note that barriers to market entry can change over time, as an industry matures, or as a result of strategic decisions made by existingcompetitors. In addition, entry barriers should never be considered insurmountable obstacles. Some small businesses are likely to possess the resources andskills that will allow them to overcome entry barriers more easily and cheaply than others. "Low entry and exit barriers reduce the risk in entering a newmarket, and may make the opportunity more attractive financially," Glen L. Urban and Steven H. Star explained in their book Advanced Marketing Strategy.But "in many cases, we would be better off selecting market opportunities with high entry barriers (despite the greater risk and investment required) sothat we can enjoy the advantage of fewer potential entrants."


Investment, especially in industries with economies of scale and/or natural monopolies.Government regulations may make entry more difficult or impossible.In the extreme case, a government may make competition illegal and establish a statutory monopoly. Requirements for licenses and permits, for example, mayraise the investment needed to enter a market.
Predatory pricing - the practice of a dominant firm selling at a loss to make competition more difficult for new firms who cannot suffer such losses, as alarge dominant firm with large lines of credit or cash reserves can. It is illegal in most places, however it is difficult to prove. See antitrust.
Intellectual property - A potential entrant requires access to equally efficient production technology as the combatant monopolist, in order to freelyenter a market. Patents give a firm the sole legal right to produce a product for a given period of time, and so restrict entry into a market. Patents areintended to encourage invention and technological progress by offering this financial incentive. Similarly, trademarks and servicemarks may represent akind entry barrier for a particular product or service if the market is dominated by one or a few well-known names.
Economy of scale - Large, experienced firms can generally produce goods at lower costs than small, inexperienced firms. Cost advantages can sometimes bequickly reversed by advances in technology. For example, the development of personal computers has allowed small companies to make use of database andcommunications technology which was once extremely expensive and only available to large corporations.
Globalisation, entry of global players into local market make entry of local players into the market difficult
Customer loyalty - large incumbent firms may have existing customers loyal to established products. The presence of established strong Brands within amarket can be a barrier to entry in this case.
Advertising - incumbent firms can seek to make it difficult for new competitors by spending heavily on advertising that new firms would find more difficultto afford.
Research and development - some products, such as microprocessors, require a massive upfront investment in technology which will deter potentialentrants.
Sunk costs - sunk costs cannot be recovered if a firm decides to leave a market; they therefore increase the risk and deter entry.
Network effect - when a good or service has a value that depends on the number of existing customers, then competing players may have difficulties to entera market where a strong player has already captured a significant user base.
Restrictive practices, such as air transport agreements that make it difficult for new airlines to obtain landing slots at some airports.
Distributor agreements, exclusive agreements with key distributors or retailers can make it difficult for other manufacturers to enter the industry.
Supplier agreements, exclusive agreements with key links in the supply chain can make it difficult for other manufacturers to enter the industry.
Inelastic demand, a strategy of selling at a lower price in order to penetrate markets is ineffective with price-insensitive consumers.
Vertical integration, that is, a firm's coverage of more than one level of production, while pursuing practices which favor its own operations at eachlevel, is often cited as an entry barrier
Cost advantages independent of scale, proprietary technology, know-how, favorable access to raw materials, favorable geographic locations, learning curvecost advantages.