No matter how hard you try, some markets have become impenetrable now. The barriers to entry to these markets may include technology challenges, government regulations or patents, huge costs, and/or licences which are really hard (or impossible) to get.
No matter how advantages, disadvantageous, or frustrating it may seem, no one would deny that barriers to entry are the biggest competitive advantage for companies which are already in the market.
But before moving ahead and diving into the mechanics of barriers of entry, here’s a quick barriers to entry definition:
What Are The Barriers To Entry?
Barriers to entry are obstacles or hindrances like high costs, government regulations, patents, or other challenges which prevent the potential entrant seller from entering the market and competing with the existing players.
Barriers to entry pose a real danger to the competitive scene since the playing field is not level and it is hardly possible for new entrants to reach the level of the existing players.
For example, an existing company serving to millions of customers might have an advantage of economies of scale and as a result, marks its product at a really low price. This competitive advantage might pose a real barrier to entry for a startup which can’t afford to sell at such a low price.
Types of Barriers to Entry
Three types of barriers to entry exist in the market today. These are natural barriers to entry, artificial barriers to entry, and government barriers to entry.
Natural Barriers To Entry
Also called structural barriers to entry, natural barriers to entry emerge naturally as the dynamics of an industry take shape and by the company’s inherent situation in the market. These include:
Economies Of Scale
Economies of scale is a proportionate saving in the costs of the goods because of an increased level of production. Many existing players who serve to the majority of the customers benefit from low production costs which results in them reducing the final price of the product as well. This acts as a big setback for the new entrants as they cannot sell the goods at the prices set by these players.
The network effect, also known as the network externality or demand-side economies of scale, states that a good or service becomes more valuable when more people use it.
For example, Whatsapp is more valuable to its users when compared to other IM apps as most of their friends use Whatsapp. This will make them reluctant to move to a different IM application as Whatsapp does the job for him.
The network effect is one of the main reasons why even Google is struggling to enter the social media networking market.
Some industries require new entrants to incur huge costs during the research and development phase and/or during the setting up. These include distribution costs, marketing costs, production costs, etc.
Many new entrants aren’t prepared for such exorbitant costs and refrain themselves from entering the market.
Access To Distribution Channels
There are times when one or a few businesses control all of the distribution channels. This poses a barrier to entry to other businesses as no business would allow its competitor to surpass itself.
Inelastic demand is the type of demand which is unaffected by the change in the price. It becomes really hard for new entrants to find a space in the market if that market witnesses such inelastic demand
Ownership Or Access to Raw Materials
There are times when the old players have control over or special access to the scarce resources. This acts as a strong barrier to entry for new businesses.
Artificial Barriers To Entry
Also called strategic barriers to entry, artificial barriers to entry are enforced explicitly by the existing players to stop potential entrants to enter the market. These include:
There are around 10 types of prominent pricings strategies in the market and each one of them, if used properly, acts as a strong barrier to entry for others in the market.
However, predatory pricing strategy (also called below the cost pricing) is often used by big players to eliminate the competition as well as close the gates for any new entrants in the market.
Many firms spend huge amounts to market their product as the best (or the only good) alternative in the market. This results in the creation of a strong brand position in the market which acts as a strong barrier to overcome.
The marketing strategies are so well executed that people start using many brand names as generic terms. For example, Jacuzzi isn’t a product, it’s a brand.
There are times when the market leader and existing players have an advantage over the others in terms of technology used. They don’t open up much about their methods and where to find that technology.
Brand & Brand Loyalty
Strong marketing strategies give rise to brand loyalty among customers who become reluctant in trying new brands.
Switching Costs For Customers
Switching cost is the monetary and non-monetary cost that the consumers incur as a result of changing brands or suppliers of products. Although a majority part of the switching cost is monetary in nature, there are also psychological, effort and time-based switching costs which act as a barrier for consumers to accept new entrants.
Patents & Other Legal Restrictions
Some pioneer brands apply for patents for their concepts and technologies, which makes it impossible for other players to enter the market and sell similar goods. Crocs is one such brand which made use of patents to lead the market.
Government Barriers To Entry
Industries that are heavily regulated by the government are most difficult to penetrate. These industries include defence contractors, airlines, railways, etc. Moreover, the government may impose import or export barrier making it really difficult for foreign businesses to enter into or move out of the local market.
It may also require businesses to obtain licences before starting the businesses or the government may declare the limitation to the access to raw materials. The government may also offer subsidiaries to certain companies making it really hard for others to cope up with them.
Barriers To Entry Examples
Google has acquired such dominant space on the internet that both the users and publishers consider it as the most trusted search engine.
The only company which has ever been able to surpass Google (in a country) is Baidu which benefitted from the Government’s decision of banning Google in China.
Facebook capitalized on the network effect. It created an easy-to-use platform to connect with friends all over the world.
Now that every friend of a person is on Facebook, there’s no need for him to choose any other social media network.
Uber disrupted the taxi industry with the help of a great idea, huge funding, and predatory pricing. It initially benefitted both the consumers and the taxi drivers (partner) and gave rise to great brand loyalty among both.
Now when that predatory pricing strategy is no more, people prefer to use uber because they have become loyal to the brand.
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A startup consultant, a dreamer, a traveller, and a philomath. Aashish has worked with over a 100 startups and successfully helped them ideate, raise money, and succeed. When not working, he can be found hiking, camping, and stargazing.