barriers-to-entry

What are barriers to entry?

Business / By / February 23, 2022

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 

  • 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 – 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 

  • 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 – 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.

Main Free Guides:

Connected Business Frameworks

Porter’s Generic Strategies

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In his book, “Competitive Advantage,” in 1985, Porter conceptualized the concept of competitive advantage, by looking at two key aspects. Industry attractiveness, and the company’s strategic positioning. The latter, according to Porter, can be achieved either via cost leadership, differentiation, or focus.

Porter’s Value Chain Model

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In his 1985 book Competitive Advantage, Porter explains that a value chain is a collection of processes that a company performs to create value for its consumers. As a result, he asserts that value chain analysis is directly linked to competitive advantage. Porter’s Value Chain Model is a strategic management tool developed by Harvard Business School professor Michael Porter. The tool analyses a company’s value chain – defined as the combination of processes that the company uses to make money.

Porter’s Diamond Model

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Porter’s Diamond Model is a diamond-shaped framework that explains why specific industries in a nation become internationally competitive while those in other nations do not. The model was first published in Michael Porter’s 1990 book The Competitive Advantage of Nations. This framework looks at the firm strategy, structure/rivalry, factor conditions, demand conditions, related and supporting industries.

Porter’s Four Corners Analysis 

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Developed by American academic Michael Porter, the Four Corners Analysis helps a business understand its particular competitive landscape. The analysis is a form of competitive intelligence where a business determines its future strategy by assessing its competitors’ strategy, looking at four elements: drivers, current strategy, management assumptions, and capabilities.

Six Forces Models

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The Six Forces Model is a variation of Porter’s Five Forces. The sixth force, according to this model, is the complementary products. In short, the six forces model is an adaptation especially used in the tech business world to assess the change of the context, based on new market entrants and whether those can play out initially as complementary products and in the long-term substitutes.

Ansoff Matrix

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You can use the Ansoff Matrix as a strategic framework to understand what growth strategy is more suited based on the market context. Developed by mathematician and business manager Igor Ansoff, it assumes a growth strategy can be derived by whether the market is new or existing, and the product is new or existing.

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BCG Matrix

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Read: BCG Matrix

Balanced Scorecard

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Read: Balanced Scorecard

Blue Ocean Strategy

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Read: Blue Ocean Strategy

PEST Analysis

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The PESTEL analysis is a framework that can help marketers assess whether macro-economic factors are affecting an organization. This is a critical step that helps organizations identify potential threats and weaknesses that can be used in other frameworks such as SWOT or to gain a broader and better understanding of the overall marketing environment.

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Scenario Planning

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Businesses use scenario planning to make assumptions on future events and how their respective business environments may change in response to those future events. Therefore, scenario planning identifies specific uncertainties – or different realities and how they might affect future business operations. Scenario planning attempts at better strategic decision making by avoiding two pitfalls: underprediction, and overprediction.

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SWOT Analysis

A SWOT Analysis is a framework used for evaluating the business’s Strengths, Weaknesses, Opportunities, and Threats. It can aid in identifying the problematic areas of your business so that you can maximize your opportunities. It will also alert you to the challenges your organization might face in the future.

Read: SWOT Analysis In A Nutshell

Growth Matrix

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Read: Growth Matrix In A Nutshell

Comparable Analysis Framework

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A comparable company analysis is a process that enables the identification of similar organizations to be used as a comparison to understand the business and financial performance of the target company. To find comparables you can look at two key profiles: the business and financial profile. From the comparable company analysis it is possible to understand the competitive landscape of the target organization.

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