Industry entry barriers are factors that make it difficult for new entrants to be able to enter an existing industry. Essentially they protect the industry from further competition – even if the industry profits are high, entry barriers act as deterrents or restrictions that make it difficult for further competitors to be able to succeed. Entry barriers are a key component of Porter’s Five Forces framework – and help explain why certain industries are associated with prolonged periods of elevated profit.
What they are, and how they allow elevated industry profit
Entry barriers are the factors that make it difficult for new firms to establish themselves in a market. They may mean that new firms face disadvantages relative to the established companies, potentially resulting in them not being able to survive. They may simply deter new firms from establishing – if the deck is essentially stacked against you, companies may decide not to compete in a market.
Entry barriers are integral to Porter’s Five Forces framework – possible the most famous strategy framework, intended to help explain why certain industries have historically remained profitable for prolonged periods of time. Essentially entry barriers protect industries from new competition. We would ordinarily expect high industry profitability to attract new firms – and as more firms enter, the competition in the market gravitates towards perfect competition (in turn reducing the profit that all firms make). Entry barriers reduce the tendency for this to happen – if a highly profitable industry is difficult for new firms to establish themselves, and in turn, the established firms are protected from intense competition.
Some examples of entry barriers
Entry barriers vary by industry – not all barriers will be at play in every setting. A key thing is to consider whether there are factors that make it difficult to establish and grow a firm, relative to the challenges that existing incumbents face.
Patents and legal protections
One important source of entry barriers is patents and other legal protections that existing firms have. Patents provide firms with exclusivity over a particular way of operating, and at the extreme can block other firms from providing those features.
Economies of scale
The requirement to operate at a high scale of production in order to see efficiency gains can also be a barrier making it harder for new firms to enter a market. A difficulty operating profitably at a small scale can prevent new firms from being able to establish themselves.
If substantial experience is required in order to become efficient in a particular area, then learning effects can act as a barrier to entry beyond economies of scale. For example, shipbuilding is a setting where learning effects are a substantial barrier to entry. The difficulty in coordinating the project means overruns and overspends are common unless you have experience in the area. Existing shipyards have decades of experience – thus, even if you were to operate at a similar scale to that shipyard in a particular year, the built-up routines and experience that they have accumulated will give them an advantage over new entrants.
Difficulties in accessing distribution channel
Another barrier facing new firms is difficulties accessing distribution channels. While selling via the internet reduces the difficulty, allowing direct sales to customers either via a company’s own website or via platforms such as Amazon and eBay, new firms still face a potential disadvantage if they have a hard time convincing retailers to stock their products.
Network effects are factors that make the service more valuable depending on the number of existing users. If we take a social network or messaging service as an example, you may gain greater benefit from using a service that your friends and colleagues are already using.
Established customer or supplier arrangements
If incumbent firms have established, long-term relationships with customers and suppliers, this can act as a barrier, preventing new firms from establishing themselves. It can be difficult to establish supplier agreements, and there may be switching costs that make customers reluctant or unable to move from their existing suppliers.
The role of entry barriers when entering a highly profitable market
Entry barriers should be a key consideration when looking to enter what, at least on paper, looks like a very attractive industry. If there are only a limited number of firms in an industry, very few firms have successfully entered the market, this is a good indication that there are likely strong barriers that would make it difficult for you to establish yourself.
It is easy to look at very profitable firms and to think ‘we could do that’. Before rushing in, it is important to systematically consider if there are reasons why the deck is stacked in favor of the incumbent, or whether there are ways of offsetting the disadvantages to allow you to enter.
If we consider social media – an area historically associated with high network effects which act as a barrier to entry (the chicken and the egg scenario where we want to be on social networks that our friends are on) – there clearly have been some new entrants within the recent history – Snapchat, TikTok, YikYak (a now-discontinued service that allowed anonymous local messages, popular among college students) and Instagram (later acquired by Facebook). In each case, the firms succeeded because they sidestepped the barriers traditionally preventing entrants in social media.
Circumventing barriers to entry
The key thing to consider when entering a market historically associated with high entry barriers is how to sidestep the barrier. Is there a way that you can enter the market without facing the barriers that would traditionally make it almost impossible to enter – if so, identifying these factors may provide the route for you to enter an otherwise difficult to enter market.
There are several things we can learn from looking at how social media firms including Snapchat, TikTok, YikYak, and Instagram were able to gain their following.
Provide new features, services, or experiences
All four of these social media firms managed to establish themselves via a relatively new concept – focusing on features and services that at least at the time were not the focus of incumbent social media firms (particularly Facebook and Twitter).
- Snapchat: Succeeded via offering time-restricted messages – allowing more free expression since the messages would disappear shortly after being opened – coupled with novelty filters that could be overlaid on the images
- YikYak: Succeeded via localized, anonymous messages – allowing you to post anonymous messages for others within the close vicinity to view (a characteristic that although led to its success, also was associated with its downfall, with the anonymous nature of messages creating a potentially toxic environment, with attempts to address by reducing the anonymity of the platform via a username being disliked).
- Instagram: Allowed images to be easily shared with a following, with filters that could easily enhance the quality of uploaded images.
- TikTok: Took the concept of Instagram one step further – shifting the focus from user and influencer generated images to videos.
While elements of each of the firms may have existed in the more established social media platforms, each of these new entrants brought new dimensions – giving users specific reasons to use the platform in addition to the other social media services.
Target customers who are not yet loyal to a particular offering
There may be a segment of the market that is not loyal to a particular offering, and this may provide the foothold to establish yourself. Snapchat pursued this direction – managing to gain a strong following among a relatively young target audience before they had adopted Facebook.
Make the barrier irrelevant
Another way that these social networks have been able to establish themselves is by negating the network effect of having your friends on the platform, by creating an experience that is not dependent on interactions with your friends. TikTok and Instagram for example are much more reliant on the content from influencers – you can gain these benefits irrespective of whether your friends are on the platform or not. Similarly, YikYak, which was based on localized anonymous messages again did not rely on having your friends on the platform – since all messages were posted anonymously, you had no idea if the messages were posted by your friends or strangers.
Final thoughts: Be aware of other firms also circumventing entry barriers
Of course, if you are able to work out a way to circumvent and enter the market, it is important to consider to what extent other firms are able to also enter the market. What may initially start out as an attractive market may be a lot less so if a lot of companies come in.
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