What are the most important barriers to entry part 5 the most important barriers to entry are?

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While there is no universally accepted list of barriers to entry, generally barriers to entry fall under three categories.

Artificial barriers to entry; Artificial barriers to entry refers to barriers that are the direct result of existing firms actions. Frequently this involves barriers centered around pricing, brand, switching costs, and customer loyalty.

Natural barriers to entry; This includes barriers such as network effects, economics of scale, and other natural barriers that are the direct results of a new entrants new position in the market place.

Government barriers to entry; Barriers to entry related to the government refer specifically to challenges for new firms face as a result of government regulations and restrictions. Governments around the world frequently create favorable conditions for particular incumbent firms that can make it challenging for new entrants.

Depending on the market, barriers to entry can include barriers in a mix of these three category buckets. Barriers to entry are

Example of Barriers to Entry

For example, a large established company is able to produce a large amount of products efficiently (low fixed costs) and more cost-effectively than a company with fewer resources. They have lower costs because they are able to purchase materials in bulk, and they have lower overhead because they are able to produce more under one roof. The smaller company would simply have a hard time keeping up with that, which can result in them avoiding entering the market altogether.

Another example of barrier to entry would be education and licensing requirements decided by the government. If you were to create an alternative school for example, you would need to spend signifiant amounts of capital on the various certifications etc which can add for new firms who may not have large amounts of cashflow.

Other firms who have already developed marketshare of a certain industry are almost always at a signifiant advantage compared to new firms. New entrants face high start up costs in addition to the challenges of growing their business. Existing firms on the other hand, enjoy cost advantages and have already established market share.

Barriers to entry can have a negative effect on prices since the playing field is not level and competition is restricted. It’s not really an ideal situation for anyone except the large company that holds the monopoly.

However, barriers to entry are not always completely prohibitive. In fact, many business startups encounter some sort of barrier to entry that they must overcome, whether that’s initial investments, acquiring licenses, or obtaining a patent – it’s just part of doing business.

Sources of Barriers to Entry

Generally speaking, entry barriers come from seven sources:

• Economies of scale: the decline in the cost of operations due to higher production volume which helps keeps fixed costs low. More established existing firms have a significant cost advantage compared to new comers.

• Product differentiation: the brand strength of the product as a result of effective communication of its benefits to the target market. It can be difficult for new entrants to "break through the noise" in their market.

• Capital requirements: One of the major economic barriers, capital requirements refers to financial resources required for operating the business. Starting a car wash business for example is more capital extensive than creating an ecommerce store.

• Switching costs: This refers to one-time costs the buyer must incur for making the switch to a different product. Your product may technically be the better solution, but if the cost to switch is too high, customers will often remain with the solutions existing firms provide.

• Access to distribution channels: does one business control all of them, or are they open? Shipping, logistics and more are a powerful barrier to entry, incumbent firms use to their advantage.

• Cost disadvantages independent of scale: when a company has advantages that cannot be replicated by the competition, such as proprietary technology.

• Government policy: controls the government has placed on the market, such as licensing requirements and other required documentation needed to start and grow a business.

Overcoming Barriers to Entry

While barriers to entry make it difficult for new entrants to establish market share, many existing firms view barriers to entry as a competitive advantage.

Some businesses want there to be high barriers to entry in their market because they want to limit competition or hold on to their place at the top. Therefore, they will try to maintain their competitive advantage any way they can, which can make entry even more difficult for new businesses.

Existing firms might do something like spend an excessive amount of money on advertising (in other words, on product differentiation), because they have it and they can, and any new entrant would not be able to do that, giving them a significant disadvantage.

When starting a business, evaluating all potential barriers to entry is a crucial step in deciding whether or not to enter a chosen market. By understanding the barriers to entry in a particular industry, new entrants can make strategic choices on how to best compete with other firms.

High start up costs, government regulations, and even predatory pricing are all challenges new entrants will likely face over the course of growing their business. But despite the disadvantages new companies may have, there's no shortage of stories of incumbent firms finally being dethroned—a classic tale of "David vs Goliath" in the world of business.

Barriers to entry generally fall under three categories, artificial, natural, and government. Natural refers to structural barriers to entry, artificial refers to strategic barriers to entry, and government refers to regulation and legal requirements established by governments.

While there are many examples of entry barriers in the market place here are a few.

• Tax benefits given to established companies in a certain industry.
• Price reduction by established companies to prevent potential entrants from competing.
• Patent protection.
• Licenses required by the government to enter a specific market.
• Brand loyalty.

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Obstacles to entering a specific market

Barriers to entry are the obstacles or hindrances that make it difficult for new companies to enter a given market. These may include technology challenges, government regulations, patents, start-up costs, or education and licensing requirements.

American economist Joe S. Bain gave the definition of barriers to entry as “an advantage of established sellers in an industry over potential entrant sellers, which is reflected in the extent to which established sellers can persistently raise their prices above competitive levels without attracting new entrants to enter the industry.” Another American economist, George J. Stigler, defined a barrier to entry as, “a 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.”

A primary barrier to entry is the cost that constitutes an economic barrier to entry on its own. An ancillary barrier to entry refers to the cost that does not include a barrier to entry by itself but reinforces other barriers to entry if they are present.

An antitrust barrier to entry is the cost that delays entry and thereby reduces social welfare relative to immediate and costly entry. All barriers to entry are antitrust barriers to entry, but the converse is not true.

Types of Barriers to Entry

There are two types of barriers:

1. Natural (Structural) Barriers to Entry

• Economies of scale: If a market has significant economies of scale that have already been exploited by the existing firms to a large extent, new entrants are deterred.
• Network effect: This refers to the effect that multiple users have on the value of a product or service to other users. If a strong network already exists, it might limit the chances of new entrants to gain a sufficient number of users.
• High research and development costs: When firms spend huge amounts on research and development, it is often a signal to the new entrants that they have large financial reserves. In order to compete, new entrants would also have to match or exceed this level of spending.
• High set-up costs: Many of these costs are sunk costs that cannot be recovered when a firm leaves a market, such as advertising and marketing costs and other fixed costs.
• Ownership of key resources or raw material: Having control over scarce resources, which other firms could have used, creates a very strong barrier to entry.

2. Artificial (Strategic) Barriers to Entry

• Predatory pricing, as well as an acquisition: A firm may deliberately lower prices to force rivals out of the market. Also, firms might take over a potential rival by purchasing sufficient shares to gain a controlling interest.
• Limit pricing: When existing firms set a low price and a high output so that potential entrants cannot make a profit at that price.
• Advertising: These are sunk costs. The higher the amount spent by incumbent firms, the greater the deterrent to new entrants.
• Brand: A strong brand value creates loyalty of customers and, hence, discourages new firms.
• Contracts, patents, and licenses: It becomes difficult for new firms to enter the market when the existing firms own licenses, patents, or exclusivity contracts.
• Loyalty schemes: Special schemes and services help oligopolists retain customer loyalty and discourage new entrants who wish to gain market share.
• Switching costs: These are the costs incurred by a customer when trying to switch suppliers. It involves the cost of purchasing or installing new equipment, loss of service during the period of change, the efforts involved in searching for a new supplier or learning a new system. These are exploited by suppliers to a large extent in order to discourage potential entrants.

Barriers to Entry in Different Market Structures

Type of market structure	Level of barriers to entry
Perfect competition	Zero barriers to entry
Monopolistic competition	Medium barriers to entry
Oligopoly	High barriers to entry
Monopoly	Very high to absolute barriers to entry

Conclusion

Barriers to entry generally operate on the principle of asymmetry, where different firms have different strategies, assets, capabilities, access, etc. Barriers become dysfunctional when they are so high that incumbents can keep out virtually all competitors, giving rise to monopoly or oligopoly.

More Resources

Thank you for reading this guide on obstacles to entering a specific market. To continue learning and advancing your career as a certified financial modeling analyst, these additional CFI resources will be helpful:

• Market Economy
• Monopoly
• Law of Supply
• Economies of Scale