Barriers to entering an industry

Barriers to Market Entry

A barrier to market entry is an obstacle (usually high costs) which prevents a product from gaining traction in a new market. Such obstacles can be natural (i.e., due to the nature of the product and the characteristics of its target market) or artificial (i.e., imposed by existing dominant players or governments to prevent newcomers and competition).

The difficulty in entering a market rests somewhere in between a monopoly (where entry is almost impossible) and a zero-cost market (where everyone can enter without facing any obstacles). While monopolies are not unheard of, in reality there is no such thing as a zero-cost market. Entering a market usually demands making an investment (even if only in time). Sometimes, this investment is significant due to the nature of the product or the market it tries to enter (e.g., high R&D costs, owning or controlling a resource, the size of the network of existing users)—these are considered to be natural barriers to entering a market. Those who do make such investments, however, then have a natural interest in preventing others from obtaining a foothold in a market—in order to limit competition and therefore maximize profit. As such, they may erect artificial barriers, through aggressive pricing strategies, advertising and image-making, predatory acquisitions, litigation, loyalty schemes, high customer-switching costs, or lobbying for government support. Regarding government support, special tax benefits for existing organizations can act as another barrier for newcomer entities.

Barriers to entry (both natural and artificial) can lead to monopolistic or oligopolistic situations in a given market. In a free society such as a liberal democracy, these then require state intervention in order to keep competition alive in that area. While such extreme circumstances are rare, designers should nevertheless be mindful of the extent of the range of barriers to entry.

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Barriers to entering an industry

Launching a business is a process fraught with hurdles. Many innovations never hit the market at all, due to what economists call “barriers to entry” – obstacles that prevent new competitors from entering an industry, thus cornering the market for existing businesses (think high start-up costs). Depending on the industry, emerging businesses may face obstacles that are relatively straightforward to overcome (low barriers to entry), those that are impossible to overcome without extensive resources (high barriers to entry) – or both.

It’s easy to see how, in searching for answers to the question of what are barriers to entry, many business owners understandably come to believe that they must achieve perfection (i.e. complete funding, a fully-staffed team and perfect economic conditions) in order to compete. Although ideal conditions make entering an industry easier, it is not conditions or circumstances that ultimately create market entry barriers. It’s your mindset , and the biggest barriers to entry stem from your own fears.

What are barriers to entry?

The barriers to entry definition, as defined by Investopedia, is the economic term describing the existence of high start-up costs or other obstacles that can prevent new competitors from easily entering an area of business or industry. They benefit existing firms due to the fact they protect their profits and revenues.

From an economist’s standpoint, both low and high barriers to entry fall into three primary categories: Natural barriers (e.g. the cost of drilling a new oil well), policy-based barriers (e.g. regulations and licensure requirements) and market-based barriers (i.e. competition from other firms in the same industry). Common barriers to entry include the struggle to accumulate start-up capital, existing patents that limit innovation by would-be competitors and cost-prohibitive regulatory clearance requirements. There are also industry-specific barriers to entering an industry. Existing businesses also have the advantage of experience, which means they have a leg up on brand identity and customer loyalty within their target market.

High barriers to entry

In discussing how to overcome market entry barriers, it is also important to remember that, ostensibly, many market barriers are put in place to protect the industry’s integrity by preventing the entry of subpar products into the marketplace. High barriers to entry provide a particularly potent measure of protection for existing firms, since high barriers make it exceedingly difficult for competitors to enter the industry. (This is true whether the barrier is natural (e.g. access to medicinal ingredients), policy-based (e.g. pharmaceutical regulations) or market-based (e.g. a lack of competition).

In discussing how to overcome market entry barriers, it is also important to remember that, ostensibly, many market barriers are put in place to protect the industry’s integrity by preventing the entry of subpar products into the marketplace. High barriers to entry provide a particularly potent measure of protection for existing firms, since high barriers make it exceedingly difficult for competitors to enter the industry. (This is true whether the barrier is natural (e.g. access to medicinal ingredients), policy-based (e.g. pharmaceutical regulations) or market-based (e.g. a lack of competition).

Monopolies and oligopolies are examples of high barriers to entry. A monopoly is a single firm that produces goods or services with no close substitute, such as a cable company that is the only service provider for a city. An oligopoly is a market with a small number of related large firms that produce similar but slightly different products. Both of these can result in a market that is incredibly difficult for a newcomer to gain a customer base, especially if they do not have a large operating or marketing budget or do not have something that makes them talkably different from their competitors.

The pharmaceutical industry is a prime case study in high barriers to entry protecting an industry posing potentially wide-ranging risks to public health. What are barriers to entry for an industry as powerful as Big Pharma? In the US, federal law mandates that in order to manufacture and market a pharmaceutical drug domestically, the manufacturer must first obtain authorization from the Federal Drug Administration (FDA). The average wait time for obtaining FDA clearance for drug manufacture is a whopping 17 months. Within this timeframe, the review process entails rounds of reviews, and just 7% and 34% of applications typically pass in the first and second rounds, respectively. Even if a drug passes the review process, it must still pass clinical trials, which cost up to $100 million per trial and have a mere one-in-ten chance of obtaining FDA approval. Even after passing clinical trials, it can still take the FDA up to 10 years to approve a drug for consumption.

The Importance of Barriers to Entry

A barrier to entry prevents and restricts competition, so it is in the interest of existing firms to create or perpetuate new and existing barriers. Businesses often do this through lobbying governments to add new regulations, grant patents, or provided favourable treatment.

It is important to understand that some barriers to entry exist naturally and therefore little can be done about them. Brand loyalty, for instance, presents a barrier to entry. If we take Amazon for example – there are few online distributors that would be able to compete. This is because customers have become accustomed to trusting the brand. Trust that would not be so forthcoming to competitors.

We can look at barriers to entry in two ways. First of all, we have ‘un-natural barriers to entry’ – so those that are man-made via government. Then second, we have ‘natural barriers to entry’. For example, brand loyalty, geographical barriers, and economies of scale.

Un-natural barriers such as patents, regulations, and trade, are all government made. Yet they prevent competition. Each has a reason for existing, but it is whether these are worth restricting competition and increasing prices.

Barriers to Entry Examples – 4 Types

1. Legal Barriers to Entry

Patents

A patent is a government-backed barrier to entry. It issues the exclusive right to produce a good for a given period of time, so competitors are legally prevented from entering the market. Some notable examples include pharmaceutical products and many in the field of technology.

Licenses/permits

Licenses and permits are another government granted barrier to entry. These are usually issued by the government to maintain quality, but reduce the level of competition at the same time. As a result, new businesses or individuals will find it hard to enter.

For example, in the US state of Arizona, a license is required for a hairdresser to be able to blow dry hair. It takes over 1,000 hours in order to obtain such a qualification. This dis-incentives would be hairdressers as it makes it unnecessarily difficult for them to enter the market, thereby reducing the level of competition.

Trade Barriers

When governments introduce quotas, tariffs, and other trade restrictions – they also restrict competition. If imported goods become too expensive due to tariffs, then customers won’t buy them – it becomes uncompetitive when compared to domestic suppliers. Consumers are more likely to buy from a domestic supplier that is half the price than a foreign import.

As a result, fewer goods come in from abroad, leaving domestic firms with little competition. Often, this is a consequence of domestic suppliers’ petition to the government to ‘protect’ jobs and the domestic market. Fewer goods coming in means less choice for consumers and higher prices as a result.

Standards and regulation

These can add extra costs to new entrants. First of all, it takes time, money, and effort to get the business up to speed with regulations. Restaurants, in particular, have a number of health and safety and other forms of regulation that owners need to be aware of.

This may require hiring a lawyer, or taking the time to research it all. Whether the final benefit is worth such costs is another matter. However, the cost imposed does provide a barrier to entry for a number of potential entrants.

2. Technical Barriers to Entry

High Start-up Costs

Some industries such as oil and gas, banking, and airlines all have extremely high start-up costs. New entrants need millions just to even enter the market. An airplane alone would cost in excess of $10 million, that’s before any costs associated with the hiring of airports, staff, and other associated costs.

Sunk Costs

A sunk cost is a cost that is unrecoverable, so presents new entrants with a big risk. Examples include advertising, marketing, and research and development. So when a new entrant spends millions in new advertising expenditure, it won’t get it back. Consequently, firms consider this when trying to enter the market. In fact, it can deter initial investment as those costs may not be recuperated.

Economies of Scale

When businesses get larger they benefit from reduced input prices. For example, supermarkets can negotiate lower prices for bread and milk, whilst small stores will struggle to negotiate with suppliers.

This makes it difficult for new entrants because they already come into the market at a disadvantage. Big stores can charge lower prices due to their size, which means new entrants are unable to effectively compete.

Monopoly / Oligopoly

In some cases, certain markets contain firms that control a significant part of the market. Microsoft, for example, dominates the operating system market. Only equally big firms such as Apple and Google have managed to even try and compete.

When markets have such strong existing firms, it is almost impossible for new start-ups to compete. This combines with other factors such as brand image, economies of scale, and power of suppliers; all factors that new entrants cannot benefit from. As a result, the upward climb is too significant for new entrants to even consider.

Geographical

In some markets, certain countries obtain a geographical advantage. Canada, for example, is known for its forestry, whilst Australia is a massive producer of iron ore. These generally occur in commodity markets whereby the production of resources is more favourable or abundant. This adds a barrier to entry as new competitors will need to be located in such a favourable location.

Technological Knowledge

When starting a new business, most owners need a certain level of expertise. For example, a restaurant owner may have worked in other restaurants, thereby earning them experience in the day to day management. However, in industries such as airlines or software, there is a significant knowledge barrier.

3. Strategic Barriers to Entry

Predatory Pricing

Another example of a barrier to entry is predatory pricing. Firms may artificially lower prices and take a loss in order to push new entrants out of the market. For example, an established local barber may reduce prices further as they know they are can compete on reputation. A new entrant may struggle to cover its costs as a result and be driven out of business.

Source:

https://www.interaction-design.org/literature/topics/barriers-to-market-entry
https://www.tonyrobbins.com/business/barriers-to-entry/
https://boycewire.com/barriers-to-entry-definition/

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