How barriers to entry influence competitive advantage.
Updated: Aug 9, 2022
As you ponder opportunities into new markets, it’s a good idea to strategically assess the barriers to entry that may restrict your progress, or enhance your competitive advantage as you grow.
During a business development workshop for solo entrepreneurs and consultants that I was facilitating, our conversation turned to competitors. One of the participants stated there were only 1200 consultants in her field in the US. And demand for their services was increasing exponentially each year. In her business, competition wasn’t a big deal. There was more demand than supply.
I asked her, “why so few consultants in a category with such high demand”?
She replied, “there’s a high barrier to entry in my profession”.
A consultant myself, I was thinking how wonderful would it be to have so few competitors in a high demand marketplace. In my profession there are most likely 20,000 consultants like me in my city alone. There are few if any high barriers to entry in the brand strategy and marketing profession. What about your business?
If you’re CEO in the early struggle phase of your business growth, I’m confident you and your team have thought about your own competitive advantage and it’s effect on how fast you take your business to the next level.
Strictly defined in theories of competition in economics, a barrier to entry, or economic barriers to entry, is a cost that must be incurred by a new entrant into a market that incumbent firms don't or no longer have to incur. Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to a host of bad outcomes for consumers and customers. Barriers to entry often cause or aid the existence of monopolies or give companies unfair market power. Our antitrust laws have been established to protect consumers from these practices.
For good or ill, barriers to entry, in all their forms, are an inescapable fact of business economics.
There are two types of barriers to entry in a given market. A primary barrier to entry is a cost that constitutes an economic barrier to entry on its own. An ancillary barrier to entry is a cost that does not constitute an economic barrier to entry by itself, but reinforces other barriers to entry if they are present.
Examples of primary barriers to market entry are:
Distributor agreements - Exclusive agreements with key distributors or retailers can make it difficult for other manufacturers to enter the industry.
Intellectual Property- Patents and copyrights give an organization the legal right to stop other firms producing a product for a given period of time, and so restrict entry into a market. Patents are intended to encourage innovation by guaranteeing proceeds as an incentive. Similarly, trademarks and servicemarks may represent a kind of entry barrier for a particular product or service if the market is dominated by one or a few well-known brand names.
Supplier agreements - Exclusive agreements with key links in the supply chain can make it difficult for other manufacturers to enter an industry.
Switching barriers- At times, it may be difficult or expensive for customers to switch providers. Software companies like Oracle make it expensive to switch to a competitor.
Tariffs- Taxes on imports prevent foreign firms from entering into domestic markets.
Taxes- Smaller companies typical fund expansions out of retained profits so high tax rates hinder their growth and ability to compete with existing firms. Larger firms may be better able to avoid high taxes through either loopholes written into tax laws favoring large companies.
Zoning- Government allows certain economic activity in specified land areas but excludes others, allowing monopoly over the land needed.
Examples of ancillary barriers to entry are:
Economies of scale- Cost advantages raise the stakes in a market, which can deter and delay entrants into the market. For example, the development of personal computers allowed smaller companies to make use of database and communications technology, once extremely expensive and only available to large corporations.
Marketing & Advertising- Incumbent firms can make it difficult for new competitors by spending heavily on advertising that new firms would find more difficult to afford or unable to staff and or undertake. Here, established brands use of marketing and advertising creates a consumer perceived difference in its brand from other brands to a degree that consumers see its brand as a slightly different product. Since the brand is seen as a slightly different product, products from existing or potential competitors cannot be perfectly substituted in place of the established firm's brand. This makes it difficult for new competitors in the category to gain consumer acceptance.
Capital - Any investment in equipment, building, and raw materials are ancillary barriers, especially including sunk costs.
Cost advantages independent of scale - Proprietary technology, know-how, favorable access to raw materials, favorable geographic locations, talent base, specialized knowledge, learning curve cost advantages.
Vertical Integration- A firm's coverage of more than one level of production, while pursuing practices favoring its own operations at each level.
Research and development - Many products, such as automobiles and microprocessors, require a large upfront investment in infrastructure that may deter potential entrants.
Customer loyalty- The presence of established strong brands within a market can be a barrier to entry in this case.
Control of resources- If a single firm has control of a resource essential for a certain industry; other firms are unable to compete in the industry.
Inelastic demand- One strategy to penetrate a market is to sell at a lower price than the incumbents. Wal-Mart came into existence and built an empire with this practice.
Predatory pricing- The practice of a dominant firm selling at a loss to make competition more difficult for new firms that cannot suffer such losses, as a large dominant firm with large lines of credit or cash reserves can. Amazon has mastered this practice
Occupational licensing- Examples include educational, state licensing and quota limits on the number of people who can enter a certain profession. The consultant I mentioned early in this post fits these criteria.
As you grow your business beyond the early struggle phase, the barrier to entry you will face will be in the mind of a customer. You can remove that barrier by innovating new and unexpected value in the marketplace rather than compete for the value already created by others.
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