Barriers to Market Entry (Encyclopedia of Small Business)
Barriers to market entry include a number of different factors that restrict the ability of new competitors to enter and begin operating in a given industry. For example, an industry may require new entrants to make large investments in capital equipment, or existing firms may have earned strong customer 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; the others include the power held by suppliers and buyers, the existing competitors and the nature of competition, and the degree to which similar products or services can act as substitutes for those provided by the industry. It is important for small business owners to understand all of these critical industry factors 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 that industry," Kenneth J. Cook explained in his book The AMA Complete Guide to Strategic Planning for Small Business. "Since both you and your competitors are in 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. If you 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 easy to enter, sources of competitive advantage tend to wane quickly. On the other hand, in industries that are difficult to enter, sources of competitive advantage last longer, and firms also tend to develop greater operational efficiencies because of the pressure of competition. The ease of entry into an industry 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 invested substantial 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 barriers to market entry:
- Economies of scale. Economies of scale occur when the unit cost of a product declines as production volume increases. When existing competitors in an industry 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 in order 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 when they cannot be duplicated by new entrantsuch as proprietary technology, favorable locations, government subsidies, good access to raw materials, and experience and learning curves.
- Product differentiation. In many markets and industries, established competitors have gained customer loyalty and brand identification through their long-standing advertising and customer service efforts. This creates a barrier to market entry by forcing new entrants to spend time and money to differentiate their products in the marketplace and overcome these loyalties.
- Capital requirements. Another type of barrier to market entry occurs when new entrants are required to invest large financial resources in order to compete in an industry. For example, certain industries may require capital investments in inventories or production facilities. Capital requirements form a particularly strong barrier when the capital is required for risky investments like research and development.
- 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 to another's. Some examples of switching costs include retraining employees, purchasing support equipment, enlisting technical assistance, and redesigning products. High switching costs form an effective entry barrier by forcing new entrants to provide potential customers with incentives to adopt their products.
- Access to channels of distribution. In many industries, established competitors control the logical channels of distribution through long-standing relationships. In order to persuade distribution channels to accept a new product, new entrants often must provide incentives in the form of price discounts, promotions, and cooperative advertising. Such expenditures act as a barrier by reducing the profitability of new entrants.
- Government policy. Government policies can limit or prevent new competitors from entering industries through licensing requirements, limits on access to raw 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 existing competitors. In addition, entry barriers should never be considered insurmountable obstacles. Some small businesses are likely to possess the resources and skills 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 new market, 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) so that we can enjoy the advantage of fewer potential entrants."
"Breaking Down Barriers to Market Entry." Management Today. April 1997.
Cook, Kenneth J. The AMA Complete Guide to Strategic Planning for Small Business. Chicago: American Marketing Association, 1995.
Geroski, Paul A. "Keeping Out the Competition." Financial Times. February 23, 1996.
Harris, Lloyd. "Barriers to Market Orientation: The View from the Shopfloor." Marketing Intelligence and Planning. March-April 1998.
Porter, Michael E. Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: Free Press, 1980.
Urban, Glen L., and Steven H. Star. Advanced Marketing Strategy. Englewood Cliffs, NJ: Prentice Hall, 1991.
SEE ALSO: Competitive Analysis