Barriers to Entry: Understanding What Limits Competition
In economics and business, the phrase “barriers to entry” refers to the circumstances that might hinder or restrict entrants from entering a market or industrial area, hence limiting competition in that market or sector. Some examples are high startup costs, regulatory impediments, and other constraints that make it difficult for new rivals to enter a particular company area. Existing businesses stand to gain from the presence of barriers to entry since these barriers safeguard their market share and their capacity to produce revenues and profits.
The following are common obstacles to entry: patent protections, strong brand identification, customer loyalty, and high customer switching costs. Special tax incentives are also often offered to existing businesses. There are further obstacles, such as requiring new businesses to get licenses or regulatory approval before they begin operations.
With an Understanding of Obstacles to Entry
Some obstacles to entry result from government involvement, while others result from natural processes within a free market. Businesses frequently lobby the government to erect additional barriers to entering an industry. To a certain extent, this is done to safeguard the industry’s integrity and prevent new competitors from introducing items of lower quality into the market.
In general, businesses seek entry barriers to reduce competition and claim a higher market share when they are already fully established in an industry. This serves the purpose of limiting competition. Another type of barrier to entry is a natural phenomenon that frequently develops over time when some industry players secure their predominant position. Primary and secondary barriers to entry are frequently distinguishable from one another.
One of the critical obstacles to entrance is a barrier that stands on its own (for example, high initial starting expenses). In and of itself, an auxiliary barrier is not considered a barrier. When combined with other obstacles, it makes it more difficult for the potential company to enter the business. In other words, it strengthens the boundaries that already exist.
There are a few different types of barriers to entry: natural (such as high initial costs to build a new oil well), established by governments (such as licensing fees or patents), or generated by other businesses (monopolists can acquire or compete away startups).
Governmental Obstacles to Entry: Industries that the government tightly controls are typically the most challenging to break into. Some examples of this type of business are cable firms, commercial aircraft, and defense contractors.
Commission of the Federal Communications Commission, “Cable Rules.”
For various reasons, the government erects intense obstacles that act as barriers to admission. In the case of commercial airlines, restrictions are not only stringent, but the government also restricts new entries to restrict air traffic and simplify monitoring. Because their infrastructure necessitates considerable use of public property, cable companies are subject to stringent regulations and restrictions.
At times, the government will establish entry barriers not because they are required but because of the pressure exerted by existing businesses through lobbying. As an illustration, to become a florist, one state requires a license from the government, while to become an interior designer, four states require a license from the government.
Some people believe that any laws placed on these kinds of businesses are pointless since they just restrict competition and stifle entrepreneurial endeavors.
Nature-caused Barriers to Entry
As the dynamics of an industry take shape, there is also the possibility that barriers to entry may organically emerge. For possible new entrants, barriers to entry consist of strong brand identification and maintaining consumer loyalty. Certain brands, such as Kleenex and Jell-O, have identities that are so powerful that their brand names are synonymous with the kinds of things that they create.
There are barriers to entry in the form of high consumer switching costs. This is because new entrants have difficulty convincing prospective consumers to spend the additional money necessary to make a shift or move.
The term “barrier to entry” can alternatively be referred to as “barrier to competition,” “entry barrier,” or “market entry barrier.”
Entry Barriers That Are Particular to the Industry
Industry sectors also have their barriers to entry, which result from the nature of the business and the position of prominent incumbents in the industry.
Manufacturing of Pharmaceuticals
For a corporation to manufacture and sell any pharmaceutical product in the United States, even a generic medication, the Food and Drug Administration (FDA) must first issue company-specific permission. It may take up to six months for the Food and Drug Administration (FDA) to approve even the most essential medications for the care of the general population.
There is a possibility that more complicated products or applications will be required to join this review cycle several times owing to modifications, even though the usual review timetable is around ten months.
In addition, only 18% of applications are accepted during the initial cycle of the process.
Each application is highly political, and their costs are considerably higher. Meanwhile, existing pharmaceutical corporations can reproduce the medicine pending evaluation and then file a particular 180-day market exclusivity patent, which steals the product and creates a temporary monopoly.
It is possible that bringing a medicine to market may require billions of dollars. To add insult to injury, the approval process for a medicine to be available for prescription can also take as long as ten years. It is possible that a new firm would not get income for ten years, even if it had the financial resources necessary to develop and test the medicine under the regulations of the FDA.
Lastly, success in the end is not at all sure. The chance of approval for development proposals for just Phase I was 7.9% from 2011 to 2020. This was estimated to be the case.
Manufacturing of Electronics
The difficulties of economies of scale and scope are more likely to affect consumer electronics used by many people. Because overhead costs, such as administration and real estate, are spread out across many units, economies of scale allow an established firm to create and distribute a few more units of current items at a lower cost. This is made possible because the company has already established itself. A small company produces a relatively small number of units, so it must divide its overhead costs by that number, making the production of each unit expensive.
To retain clients, well-established electronic corporations like Apple (AAPL) may purposefully incorporate switching fees into their pricing structures. These techniques may include contracts that are difficult to end and expensive, as well as software and data storage that cannot be moved to other electronic devices. When consumers consider moving phone service providers, they may be required to pay termination fees and suffer the expense of reacquiring apps. This is a common occurrence in the smartphone market to which consumers are exposed.
The Industry of Oil and Gas
expensive resource ownership, expensive starting costs, patents, and copyrights associated with proprietary technologies, government and environmental laws, and high fixed operating expenses are some obstacles preventing new businesses from entering the oil and gas industry. These obstacles are pretty powerful. Due to the high expenditures associated with starting a business, relatively few firms attempt to enter the market. From the very beginning, this reduces the opportunity for competition. Moreover, when joining the industry, even those with a substantial amount of starting cash are forced to contend with an instant operational disadvantage due to proprietary technologies.
Because of the high fixed operational expenses, businesses that have already established their capital are hesitant to enter the field. In addition, national and international authorities compel businesses operating within the sector to adhere strictly to environmental standards. Smaller businesses are forced out of the industry due to these restrictions, frequently demanding cash to comply with them.
Industrial Sector of Financial Services
Usually, establishing a new financial services firm does not come without significant costs. Businesses are starting to find it challenging to compete with giant corporations with scale efficiencies because of the high fixed expenses and substantial sunk costs associated with wholesale financial services. Regulatory barriers exist between commercial banks, investment banks, and other institutions. In many instances, the costs of compliance and the prospect of lawsuits are sufficient to discourage new products or businesses from entering the market.
A disproportionate amount of damage is caused to smaller businesses by the expenses of compliance and licensure. The Securities and Exchange Commission (SEC), the Truth in Lending Act (TILA), the Fair Debt Collection Practices Act (FDCPA), the Consumer Financial Protection Bureau (CFPB), the Federal Deposit Insurance Corporation (FDIC), and a plethora of other agencies and laws do not require a large-cap financial services provider to allocate as large of a percentage of its resources to ensure that it does not get into trouble with any of these agencies or laws.
What You Can Do to Overcome Obstacles to Entry
There are a variety of approaches that businesses take to circumvent or conquer obstacles to entry. The following is a list of frequent obstacles and potential strategies to overcome them.
Barriers to Trade and Economic Activity
If governments implement trade sanctions, importing or exporting items in connection with that country may become more challenging. Businesses can look for other markets with whom to collaborate or investigate whether items are explicitly exempt from trade bans. Because many government sanctions are only temporary, a corporation may choose to postpone the date of its transactions with the nation if all other options have been exhausted.
Taxes and tariffs are both taxes.
There is a possibility that businesses will decide in advance that they wish to impose additional barrier charges on customers, such as import tariffs or various taxes. There are further methods businesses might try to avoid paying taxes, such as forming partnerships with local organizations to produce goods or developing value-added activities in the local market. This allows the imported items to be evaluated at a lower value, resulting in lower assessed fees.
The Obstacles to Information
It is possible that a firm that is interested in entering or creating a new market does not have sufficient knowledge to believe that it has the potential to be successful. To overcome these obstacles, it could be better for the organization to create a minimally viable product for market research. Customers’ input may be gathered via this test product, which can also be used to mold financial planning expectations.
In addition, a corporation can think about purchasing an existing business in the market it is interested in entering. This particular firm will not only have previously conquered some of the obstacles to the entrance, if not all of them, but it may also possess expertise and information beneficial to the company’s long-term development.
The Obstacles to Market Dominance
There are certain instances in which the market leader position is so far into the future that it is pretty unlikely they will be captured in the short term. To overcome these obstacles, businesses can investigate the possibility of employing a disruptive pricing strategy and possibly risking a short-term loss to acquire long-term clients. Another possibility is for a corporation to have several goals, such as “to be the producer with the lowest costs.”
The Obstacles of Cost
An organization may explore utilizing open-source software rather than custom, proprietary software to save expenses, even though it is doubtful that many costs can be eliminated. If the firm wants to measure its financial performance, consider leasing equipment for a shorter period than making capital expenditures. It is also possible that the corporation will decide to produce only on demand or according to customer orders to prevent overcommitting resources that may have been utilized in other areas.
What Are Some Obstacles to the Entry Process?
The most apparent obstacles to entry are the high startup costs and the regulatory restrictions, which include requiring new businesses to seek licenses or regulatory approval before they can begin operations. Additionally, sectors that the government extensively controls are typically the most challenging to get into. Several other types of barriers to entry hinder new rivals from quickly joining a company sector. These include patent protections, special tax incentives for existing enterprises, strong brand identification, customer loyalty, and high customer switching costs.
For what reason would a government want to erect a barrier to entry?
Governments create barriers to entry for a variety of different reasons. In many instances, such as consumer protection legislation, these obstacles are designed to safeguard public safety. Yet they have the unintended consequence of giving an advantage to existing enterprises. In other cases, such as the licensing of broadcasting companies or the operation of commercial aircraft, the challenges are due to the inherent scarcity of the public resources that these enterprises require. In some circumstances, the government may implement entrance barriers to safeguard favored industries.
What are the natural obstacles that prevent entry?
As the dynamics of an industry take shape, there is also the possibility that barriers to entry may organically emerge. For possible new entrants, barriers to entry consist of solid brand identification and maintaining consumer loyalty. Certain brands, such as Kleenex and Jell-O, have identities that are so powerful that their brand names are synonymous with the kinds of things that they create. There are barriers to entry in the form of high consumer switching costs. This is because new entrants have difficulty convincing prospective consumers to spend the additional money necessary to make a shift or move.
Which sectors provide the most challenges to new entrants?
Industries that need a significant amount of regulation or initial capital typically have the highest barriers to entry. A significant initial investment is typically required for businesses in the following industries: telecommunications, transportation (such as automobiles or airplanes), casinos, package delivery services, pharmaceuticals, electronics, oil and gas, and financial services. Each of these sectors is subject to stringent regulations or requires significant scrutiny from the relevant regulatory organizations.
When entering a market, several factors impede organizations from doing so in various sectors. These entrance barriers may be imposed by government policy, result from high financial costs, or result from the business itself developing spontaneously. Barriers to entry protect against the easier acquisition of market share by competitors for businesses already operating inside the sector. Attempting to overcome the obstacles that hinder simple access to a sector will be a more difficult challenge for businesses interested in entering the market.
Conclusion
- The term “barriers to entry” refers to the high startup costs or other restrictions prohibiting new rivals from entering a particular sector or field of business.
- Existing businesses stand to gain from establishing barriers to entry because these barriers safeguard existing revenues and profits and prevent new competitors from taking market share.
- Barriers to entrance can be produced by natural forces, by the action of the government, or by the pressure exerted by already established businesses.
- There are a variety of obstacles to entry that are unique to each sector, and new businesses have to overcome these obstacles.
- There are a few different types of barriers to entry, including financial (when it is expensive to enter a market), regulatory (when there are laws that restrict commerce), and operational (when trying to acquire loyal consumers or when trade methods are inaccessible).
