barriers-to-entry

What are barriers to entry?

Business / By / January 28, 2023

Various interpretations of what constitutes a barrier to entry have been put forth since the 1950s. For this article, we will use the definition provided by American economist George Stigler in 1968, who stated that a barrier to entry was any “cost of producing that must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry.” In economics, therefore, barriers to entry prevent or make it difficult for new businesses to enter a specific market.

Understanding barriers to entry

Barriers to entry may arise naturally because of the particular characteristics of the market or the company itself, but they may also be imposed by firms in the market to reduce the potential for competition or by governments as an economic control measure.

The presence of entry barriers also explains why some markets are inefficient, with consumers forced to interact with monopolistic companies that charge exorbitant prices for their products and services. 

Indeed, it is worth mentioning that some barriers to entry form because different firms employ different strategies or have access to different assets, capabilities, and skillsets.

These barriers become dysfunctional when they prohibit new market entrants and encourage monopolies or oligopolies to form.

The two main types of barriers to entry

As we hinted in the previous section, there are two main types of entry barriers: natural (structural) and imposed (artificial, strategic). Let’s take a look at a few examples of each below.

Natural barriers to entry

High research and development costs

When existing firms commit resources to research and development, it can dissuade new entrants since these firms tend to have significant operating budgets.

Economies of scale

economies-of-scale
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

In a market where economies of scale have already been exploited, it is unlikely a new entrant could penetrate it and remain viable.

Sunk costs

Entering a new market is associated with several sunk costs, which is a cost that is not recoverable.

These costs, which include those related to marketing and advertising, pose a significant risk to the market entrant.

Prohibitive start-up costs

Some industries also have prohibitive start-up costs.

A new airline company, for example, needs to spend tens of millions of dollars on aircraft before it even considers the cost of employee salaries, training, permits, and airport taxes.

Geographical

Some countries can also present barriers to entry, particularly in commodities industries where resources are concentrated in specific areas.

In Australia, where iron ore is abundant, some companies will avoid entering the market because of the cost or difficulty associated with establishing operations in a foreign country.

Imposed barriers to entry

Brand loyalty

Some firms in an industry enjoy superior brand loyalty that deters new companies from trying to enter.

However, this barrier may be overcome by brand differentiation.

Patents

These are barriers to entry that are endorsed by governments and prevent competitors from legally entering a market or profiting from protected intellectual property.

The pharmaceutical industry is one such example.

Trade barriers

These encompass government-imposed tariffs, quotas, and other trade restrictions that make it difficult for companies to enter a market or remain viable.

This applies to an international company that tries to enter a domestic market where economic measures and controls are established to favor local companies.

Vertical integration

vertical-integration
In business, vertical integration means a whole supply chain of the company is controlled and owned by the organization. Thus, making it possible to control each step through consumers. in the digital world, vertical integration happens when a company can control the primary access points to acquire data from consumers.

When is a firm is vertically integrated via mergers, acquisitions, or otherwise, it controls the entire supply chain.

This makes it near impossible for another company to operate in that market.

Key takeaways

  • Barriers to entry describe a suite of economic factors that prevent or make it difficult for new businesses to enter a specific market.
  • Barriers to entry arise naturally because of the particular characteristics of the market or the company concerned. However, they may also be imposed by firms already in the market to reduce the potential for competition or by governments as a control measure.
  • Barriers to entry may be natural, such as economies of scale, prohibitive start-up costs, and geographical region. They may also be imposed, or artificial, such as vertical integration, trade barriers, patents, and brand loyalty.

What are the two types of barriers to entry?

There are two types of barriers to entry:

What are the natural barriers to entry?

What are the imposed barriers to entry?

Imposed barriers to entry comprise:

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About The Author

Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
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