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?
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 ofgovernment 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 apatent– 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.
Whenstarting 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.