Often, new companies face competitive conditions that make entry into their target market very difficult. These conditions, or market entry barriers make the market less attractive for new entrants and therefore, existing players in the industry strive to create and maintain them. Situations like stringent licensing, government regulations, high skill requirements or high funding requirements are just some examples of potential barriers to entry.
An industry with high entry barriers is most attractive to investors and financiers. This is because the potential for profit and return on investment is higher. Fewer players in the market mean less competition and higher margins for the few companies offering the product or service to customers.
If an industry has lower barriers to entry, there is a risk of market saturation. This makes the business more competitive with too many products and services available to fulfil customer needs. In turn, this will make it harder to recover investment and gain higher profit margins.
In this article we will look at 1) types of market entry barriers, 2) how to create market entry barriers, and 3) issues with market entry barriers.
- 1 TYPES OF MARKET ENTRY BARRIERS
- 1.1 1. Patents and Licenses
- 1.2 2. Established Brands
- 1.3 3. Established Distribution networks
- 1.4 4. Exclusive Rights to Resources
- 1.5 5. Government Regulations and Laws
- 1.6 6. Achieved Economies of Scale
- 1.7 7. Business Tactics
- 1.8 8. Switching Costs
- 1.9 9. Capital Investment Requirements
- 1.10 10. High Research and Development Costs
- 2 HOW TO CREATE MARKET ENTRY BARRIERS
- 2.1 Creating and Maintaining an Economic Moat
- 2.2 Does Your Business Have Potential to Create Barriers?
- 2.3 Strategies to Create Long Term Barriers
- 3 ISSUES WITH MARKET ENTRY BARRIERS
TYPES OF MARKET ENTRY BARRIERS
There are many types of market entry barriers that can restrict new entrants from approaching an industry or market. Some of these are such that they can be controlled by the companies themselves while others are those imposed by a government or by an industry regulating authority. Some of these barriers are:
1. Patents and Licenses
If an existing player holds the patent for a product for a number of coming years, then it makes no sense for a new player to enter the market at that point in time. Prime examples of this are pharmaceutical companies, where patents may bar a new company from manufacturing and marketing medicines till the original company holds the patent.
2. Established Brands
If the market has one or two giant brand names, then it may be impossible for a newcomer to go head to head with them. There are companies which manage to make their brand name synonymous with the actual product itself. They may also have managed to gain complete customer trust in the quality of their product or service so much so that the customer would not switch even for a lesser priced version. Some examples of this kind of brand presence are Coca Cola and Pepsi, where sometimes even new versions of their own products are unable to stand up to the regular familiar products.
3. Established Distribution networks
If a company has been operating in an industry for a number of years, they have had the time to build up a strong distribution network and channels. They know all the key persons in the machinery that takes their product to the customer and are able to streamline it’s working to perfection. Competing with a detailed network may not be possible for a new entrant.
4. Exclusive Rights to Resources
If an incumbent has exclusive legal rights to resources required by the industry, then the newcomer may be put in the position of having to purchase resources from their own competitor. This may not make good business sense as it will add to the cost of doing business and not allow the new party to price competitively.
5. Government Regulations and Laws
For many industries, there is a strict set of rules governing licenses, policies and rules of doing business. Often the cost associated with meeting regulations and standards and achieving necessary permits and licenses does not make business sense for a new player. In other instances, a country may not have strong enough laws to justify doing business. This may be true cases where intellectual property is at risk and no intellectual property laws exist to protect creative product.
6. Achieved Economies of Scale
When manufacturing in larger quantities, the total cost of the product is often reduced. This is known as economies of scale. Achieving this scale advantage requires a lot of initial inflow of investment to pay for the set up costs associated with large scale manufacturing. This is not possible for newer smaller businesses and often acts as a significant barrier to entry.
7. Business Tactics
If a company has been doing business in an industry successfully, it may have the financial leeway to lower their prices at the cost of some percentage of profits. This will also reduce profit margins for the new entrant if they want to remain competitive. And if they price according to the old model, their product will not remain competitive. An incumbent may also be in a position to put forward special offers or product bundles which may not be possible for a new company to do.
8. Switching Costs
Some products or services may have switching costs associated with them, making it difficult for a customer to move to a new company. Sometimes, cell phone services lock customers into year or two year long deals where moving out of them means suffering a loss of investment. Most people will stick to their provider rather than lose out on money they have paid. These switching costs are both financial and legal.
9. Capital Investment Requirements
In some markets, there may be hefty investment requirements for setting up operations. In the case of a manufacturing company, large pieces of equipment and infrastructure costs may be so significant that it may not make a good business case for investment. Apart from startup costs, ongoing high investment scenarios may also be a hindrance. If there is a rapid change in technology and a requirement for the company to keep up, then it may need a constant influx of cash to remain competitive.
10. High Research and Development Costs
If an industry requires significant research and development for success, or there is an incumbent who spends considerable resources of this, then it is a signal to competitors that the company has strong cash reserves and a will to stay in the business long term. This requirement for R&D may act as a strong deterrent for a potential new entrant.
HOW TO CREATE MARKET ENTRY BARRIERS
Dirty Little Startup Secret: Barriers to Entry
Successful companies will always try to create and maintain competitive advantages over other companies in their industry. These competitive advantages translate into entry barriers to the market and act as a deterrent for potential competitors assessing the market for entry. The more long term and strategically thought out these advantages are, the better it is for the business. This is where the concept of an economic moat is extremely relevant.
Creating and Maintaining an Economic Moat
A term coined by the very successful investor Warren Buffet, an economic moat is simply the competitive advantage one company has over another in the same industry. If the business is like a castle, then the moat around it serves to protect the company from infringements on its profits and customers by a new entrant or an existing competitor. The wider the moat, the more long term and sustainable the protection it affords the incumbent. The following steps can help a company widen the moat around itself and keep competitors, both existing and potential, safely on the other side:
Identify and Understand Intangible Assets
The first step to creating a sustainable competitive advantage is to understand what assets the company has. Tangible assets are easy to identify and listed on financial statements. The source of an advantage however, is more likely to be hidden among the more intangible assets of the company. These may include streamlined processes, propriety designs and trade secrets, patents and copyrights, government approvals and licenses, strong brand names, customized software databases and business solutions, exclusive contracts and an established supply chain and distribution channel.
An understanding of these assets will lead to strategies to protect them from competitors.
Understand reasons for customer goodwill
Once intangible assets are listed, it is necessary to understand why there is customer goodwill towards your product. Is the product so much better than others that customers feel compelled to talk it up to others? Is there a lot of word of mouth referral? Are there reliable delivery timelines? Is there customer confidence that you will go the extra mile? Do you have a high percentage success rate in getting the job done?
If reasons for success with customers are correctly understood, then there can be conscious effort to keep doing the right things and eliminate steps that create no value.
Develop Cost Advantages
Through an efficient business model, you can work towards providing great products and services at reasonable costs. The business should be able to transform with changing market dynamics and trends. Economies of scale can also help develop significant cost advantages. A business with high switching costs also manages to keep a healthy competitive advantage. These switching costs can be financial, legal or even emotional.
Does Your Business Have Potential to Create Barriers?
To check if your business has moat or the potential to create barriers to entry, ask yourself the following questions
- Is the Firm Profitable? The questions to ask here are pertinent to the company’s historical profitability. Has there been a solid return on assets? Has there been a steady return on investment? This is the most basic assessment of whether the company has a wide moat or not
- What is the Source of these Profits? If the company has solid profits and consistent returns, then the next stage is to clearly identify where these profits are coming from. Is it an advantage unique to the company or is it easily copied. The more difficult an advantage is to achieve by a competitor the bigger the barriers to entry
- How large is the Competitive Advantage? If there is a significant competitive advantage at the root of the company’s profits, it is necessary to identify how long term and sustainable it is. If it is only several months then the barrier to entry is not that high. If it is several years or decades, then the company has a significant moat to keep competitors out.
- Is the Industry Competitive? Another vital area to identify is the nature of the industry in which the company operates. Is it a highly competitive one or with just a few company’s operating. A more competitive industry will eventually mean lower attractive profits and growth over the long term.
Strategies to Create Long Term Barriers
By now, it is quite clear that the key to a successful business is to create and maintain long term sustainable barriers to entry. With more strategic barriers to entry the company will be able to enjoy sustained profits and returns on investment. Some key areas of focus for achieving these barriers are:
Behave like a Leader
If you want your company to be a leader, it is important to demonstrate this in each aspect of the business. Make sure that each and every area is professional and polished. Begin with a quality product that meets a specific customer need. Build on this with a strong marketing campaign that is though through and detailed. Have smart sales people and a streamlined distribution channel. Approach everything critically and be willing to make any changes necessary to maintain a leadership position. Stay ahead of the game by anticipating changes in the market and customer trends.
Understand your Strengths and Weaknesses
Take a realistic view of what you are good at and what needs work. Strive to build up on the strengths. If you offer a wider variety of services or products than competitors, than make sure your offering remains the largest. Keep building on your competitive advantage so that competitors do not have a chance to catch up.
Be True to your Customers
Keep a close eye on what your customer needs and if there is a change in behaviour. With this understanding, make sure that all your communication directed at the customer is real and relevant. If there appears to be a change in customer behaviour or needs, try to stay ahead of them, anticipate them and change the product offering right on time.
It is important for a company to keep open channels to its customers. Loyalty and reward programs will help maintain an emotional bond with a company and its product and result in a high switching cost for the customer.
Create a referral system
It is a smart idea to involve customers in bringing their peers on board. Build incentives for customers to talk about your product to others. This will help build a loyal customer base that will not be ripe for picking if a new competitor starts sniffing out business sustainability.
ISSUES WITH MARKET ENTRY BARRIERS
Though market entry barriers offer a considerable relief to companies from new entrants constantly breathing down their necks, it is extremely important for any organization to not let down its guard. A strong and detailed mechanism always needs to be in place to assess the industry and identify any weak areas that can become a point of entry for competition. It is a common mistake for a company to become complacent with its barriers in place. It will take one instance of disruptive innovation to render all barriers completely void. A disruptive innovation changes the basis for competition in the market. This breaks down existing barriers and creates a whole new playing field with incumbents left at a severe disadvantage of offering products or services that are no longer relevant or needed.
In order to create real, sustainable and successful barriers to entry, a company needs to create as much of a competitive advantage as it can. It is also important to keep a clear eye on the horizon and anticipate any potential changes in the market or in the customer. With a strategic focus and vigilant market analyses, a company can manage to maintain strong barriers to entry for many years.
Guide on Barriers for Market Entry and Exit