The higher the entry barriers the more intense is competition in an industry

A barrier to entry is something that blocks or impedes the ability of a company (competitor) to enter an industry. A barrier to exit is something that blocks or impedes the ability of a company (competitor) to leave an industry.

In general, industries that are difficult for new competitors to enter may enjoy periods of good profitability and limited rivalry among competitors. Conversely, industries that are easy to enter attract new companies into the industry during periods of profitability. So, rivalry among competitors can be intense. On the other end, industries that are difficult to exit have more rivalry than industries that are easy to leave.

Some of the common barriers to entry and exit are listed below.

Typical Barriers to Entry

• Economies of size - The need for a large volume of production and sales to reach the cost level per unit of production for profitability is a barrier to entry.
• Capital intensive - A large capital investment per unit of output in facilities tends to limit industry entry.
• Intellectual property - Patents and other types of proprietary intellectual property are very effective in limiting industry entry.
• High switching costs - The tendency for buyers of an industry’s products to be reticent about switching to a new supplier tends to limit entry.
• Established brand identity - Industries dominated by branded products are difficult to enter due to the large amount of time and money required to create a competing branded product.
• Permitting requirements - Industries where permitting and licenses are required to establish production tend to have limited entry.
• Government standards - Industries where rigid industry standards exist tend to have limited entry.

Typical Barriers to Exit

• Investment in specialist equipment - Investments in specialized equipment that cannot readily be used in other industries tends to be an impediment to leaving the industry.
• Specialized skills - Highly specialized skills by industry participants that cannot be utilized in other industries tend to be an impediment to leaving the industry.
• High fixed costs - High levels of dedicated fixed costs tend to be an impediment to leaving an industry

If we combine entry and exit, we can predict industry rivalry, stability and profitability. As shown in Figure 1, an industry that is easy to enter but difficult to leave has intense industry rivalry and low profitability. At the first sign of excess profitability in the industry, competitors flock to the industry. However, when profitability falls, it is difficult to leave the industry so profitability remains low.

Conversely, an industry that is difficult to enter but easy to leave is shown in Figure 2. It has limited industry rivalry and tends to have good profitability. Competitors have a difficult time entering the industry during times of good profitability. However, during period of low profitability, competitors leave the industry easily.

Conversely, an industry that is difficult to enter but easy to leave is shown in Figure 2. It has limited industry rivalry and tends to have good profitability. Competitors have a difficult time entering the industry during times of good profitability. However, during period of low profitability, competitors leave the industry easily.

Industries that are difficult to enter and difficult to exit are shown in Figure 4. The size and composition of the industry is static and changes slowly. Supply changes slowly due to market signals so price responds strongly to changes in demand. The amount of rivalry can change radically due to changes in demand.

When starting a new business, or bringing a new product to market, there's no shortage or factors that affect the odds of potential success. By understanding barriers to entry and how they impact the competitive landscape, new firms can put themselves in a stronger position to compete with existing firms in a given industry.

New entrants in a market will always have an uphill battle to climb especially in the case of high start up costs. Fortunately, for many ecommerce businesses, the natural barriers that often keep new entrants from seeing growth compared to their competition is not a major factor.

In this guide, we'll cover the basics of barrier to entry and explore how each of the barriers to entry impact business success.

What is Barrier to Entry?

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Barrier to entry is the high cost or other type of barrier that prevents a business startup from entering a market and competing with other businesses. Barriers to entry are frequently discussed in the context of economics and general market research.

Barriers to entry can include government regulations, the need for licenses, and having to compete with a large corporation as a small business startup.

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.

Barrier to Entry FAQ

What are the official Barriers to entry?

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.

What are some examples of Barriers to Entry?

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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