Sources of Barriers to Entry
Barriers to entry are obstacles that make it difficult to enter a given market. The term can refer to hindrances a firm faces in trying to enter a market or industry. It benefits existing companies already operating in an industry because they protect an established company’s revenues and profits from being whittled away by new competitors.
There are seven sources of barriers to entry:
(1) Economies of scale
These are declines in the unit costs of a product as the absolute volume per period increases. These force the entrant to either come in at a large scale (risking a strong reaction from incumbents) or a small scale (forcing a cost disadvantage).
(2) Product differentiation
Incumbents have brand identification and customer loyalties. This forces entrants to spend heavily to overcome these loyalties. Startups may bring a different product to the market, but its benefits must be clearly communicated to the target customer. Startups must find an effective positioning, which often requires marketing resources beyond their means.
(3) Capital requirements
These are the financial resources required for infrastructure, machinery, R&D, and advertising. Startups may get around capital requirements by outsourcing parts of the operation to companies that can leverage existing investments.
(4) Switching costs
These are one-time costs the buyer faces when switching an existing supplier’s product to a new entrant (for example, employee retraining, new equipment, and technical support).
(5) Access to distribution channels
This can be a barrier if logical distribution channels have been locked up by incumbents.
(6) Cost disadvantages independent of scale:
Incumbents may have cost advantages that cannot be replicated by a potential entrant. Factors include the learning or experience curve, proprietary product technology, access to raw materials, favorable locations, and government subsidies.
(7) Government policy
Governments can limit or prevent entry to industries with various controls (for example, licensing requirements, and limits to access to raw materials). Startups in highly regulated industries will find that incumbents have fine-tuned their business according to regulation.