Barriers to entry
Encyclopedia
In theories of competition
in economics
, 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
- such as government regulation
, or a large, established firm taking advantage of economies of scale
- or those an individual faces in trying to gain entrance to a profession - such as education or licensing requirements.
Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to distortionary prices. The existence of monopolies or market power
is often aided by barriers to entry.
defined an entry barrier as “A cost of producing which must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry”.
Joe S. Bain defined as a barrier to entry anything that allows incumbent firms to earn supranormal profits without threat of entry.
limits on the number of people who can enter a certain profession such as that of lawyer
, and educational, licensing, and experiential requirements for people who wish to be neurosurgeons.
Whilst both types of barriers to entry attempt to guarantee that people entering those fields are suitably qualified, the barriers to entry also reduce competition. This has the effect of facilitating premium pricing for the services of regulated professions. That is, if just anyone could enter these fields, the income of the incumbents would be expected to be lower.
classifies the markets into four general cases:
The higher the barriers to entry and exit, the more prone a market tends to be a natural monopoly
. The reverse is also true. The lower the barriers, the more likely the market will become perfect competition
.
Competition (economics)
Competition in economics is a term that encompasses the notion of individuals and firms striving for a greater share of a market to sell or buy goods and services...
in economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, barriers to entry are obstacles that make it difficult to enter a given market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
. The term can refer to hindrances a firm faces in trying to enter a market or industry
Industry
Industry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...
- such as government regulation
Regulation
Regulation is administrative legislation that constitutes or constrains rights and allocates responsibilities. It can be distinguished from primary legislation on the one hand and judge-made law on the other...
, or a large, established firm taking advantage of economies of scale
Economies of scale
Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...
- or those an individual faces in trying to gain entrance to a profession - such as education or licensing requirements.
Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to distortionary prices. The existence of monopolies or market power
Market power
In economics, market power is the ability of a firm to alter the market price of a good or service. In perfectly competitive markets, market participants have no market power. A firm with market power can raise prices without losing its customers to competitors...
is often aided by barriers to entry.
Definitions
George StiglerGeorge Stigler
George Joseph Stigler was a U.S. economist. He won the Nobel Memorial Prize in Economic Sciences in 1982, and was a key leader of the Chicago School of Economics, along with his close friend Milton Friedman....
defined an entry barrier as “A cost of producing which must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry”.
Joe S. Bain defined as a barrier to entry anything that allows incumbent firms to earn supranormal profits without threat of entry.
Barriers to entry for firms into a market
Barriers to entry into markets for firms include:- AdvertisingAdvertisingAdvertising is a form of communication used to persuade an audience to take some action with respect to products, ideas, or services. Most commonly, the desired result is to drive consumer behavior with respect to a commercial offering, although political and ideological advertising is also common...
- Incumbent firms can seek to make it difficult for new competitors by spending heavily on advertising that new firms would find more difficult to afford. This is known as the market power theory of advertising. Here, established firms' use of advertising creates a consumer perceived difference in its brand from other brands to a degree that consumers see its brand as a slightly different product. Since the brand is seen as a slightly different product, products from existing or potential competitors cannot be perfectly substituted in place of the established firm's brand. This makes it hard for new competitors to gain consumer acceptance. - Capital - need the capital to start up such as equipment, building, and raw materials
- Control of resources - If a single firm has control of a resource essential for a certain industry, then other firms are unable to compete in the industry.
- Cost advantages independent of scale - Proprietary technology, know-how, favorable access to raw materials, favorable geographic locations, learning curve cost advantages.
- Customer loyalty - Large incumbent firms may have existing customers loyal to established products. The presence of established strong brands within a market can be a barrier to entry in this case.
- Distributor agreements - Exclusive agreements with key distributors or retailers can make it difficult for other manufacturers to enter the industry.
- Economy of scale - Large, experienced firms can generally produce goods at lower costs than small, inexperienced firms. Cost advantages can sometimes be quickly reversed by advances in technology. For example, the development of personal computerPersonal computerA personal computer is any general-purpose computer whose size, capabilities, and original sales price make it useful for individuals, and which is intended to be operated directly by an end-user with no intervening computer operator...
s has allowed small companies to make use of databaseDatabaseA database is an organized collection of data for one or more purposes, usually in digital form. The data are typically organized to model relevant aspects of reality , in a way that supports processes requiring this information...
and communicationCommunicationCommunication is the activity of conveying meaningful information. Communication requires a sender, a message, and an intended recipient, although the receiver need not be present or aware of the sender's intent to communicate at the time of communication; thus communication can occur across vast...
s technology which was once extremely expensive and only available to large corporations. - Government regulations - It may make entry more difficult or impossible. In the extreme case, a government may make competition illegal and establish a statutory monopoly. Requirements for licenses and permits may raise the investment needed to enter a market, creating an effective barrier to entry.
- Inelastic demand - One strategy to penetrate a market is to sell at a lower price than the incumbents. This is ineffective with price-insensitive consumers.
- Intellectual propertyIntellectual propertyIntellectual property is a term referring to a number of distinct types of creations of the mind for which a set of exclusive rights are recognized—and the corresponding fields of law...
- Potential entrant requires access to equally efficient production technology as the combatant monopolist in order to freely enter a market. PatentPatentA patent is a form of intellectual property. It consists of a set of exclusive rights granted by a sovereign state to an inventor or their assignee for a limited period of time in exchange for the public disclosure of an invention....
s give a firm the legal right to stop other firms producing a product for a given period of time, and so restrict entry into a market. Patents are intended to encourage inventionInventionAn invention is a novel composition, device, or process. An invention may be derived from a pre-existing model or idea, or it could be independently conceived, in which case it may be a radical breakthrough. In addition, there is cultural invention, which is an innovative set of useful social...
and technologicalTechnologyTechnology is the making, usage, and knowledge of tools, machines, techniques, crafts, systems or methods of organization in order to solve a problem or perform a specific function. It can also refer to the collection of such tools, machinery, and procedures. The word technology comes ;...
progress by offering this financial incentive. Similarly, trademarkTrademarkA trademark, trade mark, or trade-mark is a distinctive sign or indicator used by an individual, business organization, or other legal entity to identify that the products or services to consumers with which the trademark appears originate from a unique source, and to distinguish its products or...
s and servicemarks may represent a kind of entry barrier for a particular product or service if the market is dominated by one or a few well-known names. - InvestmentInvestmentInvestment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
- That is especially in industries with economies of scaleEconomies of scaleEconomies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...
and/or natural monopolies. - Network effectNetwork effectIn economics and business, a network effect is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it.The classic example is the telephone...
- When a good or service has a value that depends on the number of existing customers, then competing players may have difficulties in entering a market where an established company has already captured a significant user base. - Predatory pricingPredatory pricingIn business and economics, predatory pricing is the practice of selling a product or service at a very low price, intending to drive competitors out of the market, or create barriers to entry for potential new competitors. If competitors or potential competitors cannot sustain equal or lower prices...
- The practice of a dominant firm selling at a loss to make competition more difficult for new firms that cannot suffer such losses, as a large dominant firm with large lines of credit or cash reserves can. It is illegal in most places; however, it is difficult to prove. See antitrustAntitrustThe United States antitrust law is a body of laws that prohibits anti-competitive behavior and unfair business practices. Antitrust laws are intended to encourage competition in the marketplace. These competition laws make illegal certain practices deemed to hurt businesses or consumers or both,...
. In the context of international trade, such practices are often called dumpingDumping (pricing policy)In economics, "dumping" is any kind of predatory pricing, especially in the context of international trade. It occurs when manufacturers export a product to another country at a price either below the price charged in its home market, or in quantities that cannot be explained through normal market...
. - Restrictive practices, such as air transport agreements that make it difficult for new airlines to obtain landing slots at some airportAirportAn airport is a location where aircraft such as fixed-wing aircraft, helicopters, and blimps take off and land. Aircraft may be stored or maintained at an airport...
s. - Research and developmentResearch and developmentThe phrase research and development , according to the Organization for Economic Co-operation and Development, refers to "creative work undertaken on a systematic basis in order to increase the stock of knowledge, including knowledge of man, culture and society, and the use of this stock of...
- Some products, such as microprocessors, require a large upfront investment in technology which will deter potential entrants. - Supplier agreements - Exclusive agreements with key links in the supply chain can make it difficult for other manufacturers to enter an industry.
- Sunk costSunk costIn economics and business decision-making, sunk costs are retrospective costs that have already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken...
s - Sunk costs cannot be recovered if a firm decides to leave a market. Sunk costs therefore increase the riskRiskRisk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
and deter entry. - Switching barriersSwitching barriersSwitching barriers or switching costs are terms used in microeconomics, strategic management, and marketing to describe any impediment to a customer's changing of suppliers....
- At times, it may be difficult or expensive for customers to switch providers - Tariffs - Taxes on imports prevent foreign firms from entering into domestic markets.
- Vertical integrationVertical integrationIn microeconomics and management, the term vertical integration describes a style of management control. Vertically integrated companies in a supply chain are united through a common owner. Usually each member of the supply chain produces a different product or service, and the products combine to...
- A firm's coverage of more than one level of production, while pursuing practices which favor its own operations at each level, is often cited as an entry barrier - ZoningZoningZoning is a device of land use planning used by local governments in most developed countries. The word is derived from the practice of designating permitted uses of land based on mapped zones which separate one set of land uses from another...
- Government allows certain economic activity in specified land areas but excludes others.
Barriers to entry for individuals into the job market
Examples of barriers restricting individuals from entering a job market include educational, licensing, or quotaQuota share
A quota share is a specified number or percentage of the allotment as a whole , that is prescribed to each individual entity ....
limits on the number of people who can enter a certain profession such as that of lawyer
Lawyer
A lawyer, according to Black's Law Dictionary, is "a person learned in the law; as an attorney, counsel or solicitor; a person who is practicing law." Law is the system of rules of conduct established by the sovereign government of a society to correct wrongs, maintain the stability of political...
, and educational, licensing, and experiential requirements for people who wish to be neurosurgeons.
Whilst both types of barriers to entry attempt to guarantee that people entering those fields are suitably qualified, the barriers to entry also reduce competition. This has the effect of facilitating premium pricing for the services of regulated professions. That is, if just anyone could enter these fields, the income of the incumbents would be expected to be lower.
Classification and examples
Michael PorterMichael Porter
Michael Eugene Porter is the Bishop William Lawrence University Professor at Harvard Business School. He is a leading authority on company strategy and the competitiveness of nations and regions. Michael Porter’s work is recognized in many governments, corporations and academic circles globally...
classifies the markets into four general cases:
- High barrier to entry and high exit barrierBarriers to exitIn economics, barriers to exit are obstacles in the path of a firm which wants to leave a given market or industrial sector. These obstacles often cost the firm financially to leave the market and may prohibit it doing so....
(for example, telecommunications, energyEnergy industryThe energy industry is the totality of all of the industries involved in the production and sale of energy, including fuel extraction, manufacturing, refining and distribution...
) - High barrier to entry and low exit barrier (for example, consultingConsultantA consultant is a professional who provides professional or expert advice in a particular area such as management, accountancy, the environment, entertainment, technology, law , human resources, marketing, emergency management, food production, medicine, finance, life management, economics, public...
, educationEducationEducation in its broadest, general sense is the means through which the aims and habits of a group of people lives on from one generation to the next. Generally, it occurs through any experience that has a formative effect on the way one thinks, feels, or acts...
) - Low barrier to entry and high exit barrier (for example, hotelHotelA hotel is an establishment that provides paid lodging on a short-term basis. The provision of basic accommodation, in times past, consisting only of a room with a bed, a cupboard, a small table and a washstand has largely been replaced by rooms with modern facilities, including en-suite bathrooms...
s, ironworksIronworksAn ironworks or iron works is a building or site where iron is smelted and where heavy iron and/or steel products are made. The term is both singular and plural, i.e...
) - Low barrier to entry and low exit barrier (for example, retailRetailRetail consists of the sale of physical goods or merchandise from a fixed location, such as a department store, boutique or kiosk, or by mail, in small or individual lots for direct consumption by the purchaser. Retailing may include subordinated services, such as delivery. Purchasers may be...
, electronic commerceElectronic commerceElectronic commerce, commonly known as e-commerce, eCommerce or e-comm, refers to the buying and selling of products or services over electronic systems such as the Internet and other computer networks. However, the term may refer to more than just buying and selling products online...
)
- Markets with high entry barriers have few players and thus high profit marginProfit marginProfit margin, net margin, net profit margin or net profit ratio all refer to a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue.Net profit Margin = x100...
s. - Markets with low entry barriers have lots of players and thus low profit margins.
- Markets with high exit barriers are unstable and not self-regulated, so the profit margins fluctuate very much over time.
- Markets with a low exit barrier are stable and self-regulated, so the profit margins do not fluctuate much over time.
The higher the barriers to entry and exit, the more prone a market tends to be a natural monopoly
Natural monopoly
A monopoly describes a situation where all sales in a market are undertaken by a single firm. A natural monopoly by contrast is a condition on the cost-technology of an industry whereby it is most efficient for production to be concentrated in a single form...
. The reverse is also true. The lower the barriers, the more likely the market will become perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
.
Barriers to entry and market structure
- Perfect competitionPerfect competitionIn economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
: Zero barriers to entry. - Monopolistic competitionMonopolistic competitionMonopolistic competition is imperfect competition where many competing producers sell products that are differentiated from one another...
: Low barriers to entry. - OligopolyOligopolyAn oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
: High barriers to entry. - MonopolyMonopolyA monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
: Very High to Absolute barriers to entry.
See also
- Anti-competitive practicesAnti-competitive practicesAnti-competitive practices are business or government practices that prevent or reduce competition in a market .- Anti-competitive practices :These can include:...
- Barriers to exitBarriers to exitIn economics, barriers to exit are obstacles in the path of a firm which wants to leave a given market or industrial sector. These obstacles often cost the firm financially to leave the market and may prohibit it doing so....
- Exclusive dealingExclusive dealingExclusive dealing refers to when a retailer or wholesaler is ‘tied’ to purchase from a supplier on the understanding that no other distributor will be appointed or receive supplies in a given area...
- Market powerMarket powerIn economics, market power is the ability of a firm to alter the market price of a good or service. In perfectly competitive markets, market participants have no market power. A firm with market power can raise prices without losing its customers to competitors...
- Starting a Business IndexStarting a Business IndexThe Starting a Business Index is a sub-index of the World Bank Ease of Doing Business Index.- Authors of the methodology :This methodology was developed by Simeon Djankov, Rafael La Porta, Florencio Lopez-De-Silanes and Andrei Shleifer in a paper The Regulation of Entry.- Ranking :Ranking of all...
- Strategic entry deterrenceStrategic entry deterrenceIn business, strategic entry deterrence refers to any action taken by an existing business in a particular market that discourages potential entrants from entering into competition in that market...
- Switching barriersSwitching barriersSwitching barriers or switching costs are terms used in microeconomics, strategic management, and marketing to describe any impediment to a customer's changing of suppliers....
- Zero-profit conditionZero-profit conditionIn economic competition theory, the zero-profit condition describes the condition that occurs when an industry or type of business has an extremely low cost of entry...