Barrier to Strategic Entry: Understanding, Classifications, Illustrative Examples
In the competitive world of business, established companies often employ strategic measures to protect their market share from new entrants. These strategic entry barriers, also known as artificial barriers to entry or strategic entry deterrence, are deliberate actions taken by old players to prevent new players from entering the market.
One such method is lowering prices as a signal of efficiency. Incumbents can leverage their low-cost structures, first-mover advantages, and benefits from economies of scale and the experience curve to offer prices that are difficult for newcomers to match.
Other types of strategic entry barriers include signaling, advertisement, brand, contracts, patents, and licenses, and switching costs. If the incumbent has a license or patent, potential players must develop a new product from scratch, increasing entry costs. High switching costs may prevent new entrants from offering low prices as an incentive, as the costs of switching may exceed the difference in price between the entrant and the incumbent.
Acquisitions are another way of creating and increasing the credibility of barriers to entry. By taking over a potential rival or acquiring another company in one production chain, the incumbent can deter new players from entering the market.
Real-world examples of strategic entry barriers used by incumbent companies to deter new players are plentiful. Preemptive rights in share acquisition, where existing shareholders hold the option to buy new shares before outsiders, limit new investors' ability to gain a foothold and deterring strategic capital inflows or acquisitions by potential competitors.
Incumbents can also leverage patent protections combined with systemic resistance to stifle disruptive technologies that challenge established market norms and infrastructures. For instance, large incumbents achieve high efficiency and lower unit costs through massive operations, posing a cost disadvantage to new entrants who cannot match the scale.
Firms that control essential inputs or resources create significant entry barriers, as seen in the oil industry oligopoly where key countries and companies manage global supply and pricing to exclude newcomers. Markets like airlines and pharmaceuticals feature enormous upfront investments and complex legal/regulatory hurdles, which incumbents often navigate more easily, deterring smaller or new firms.
In pharmaceutical markets, companies launching the first generic version after patent expiry gain a sticky market share advantage that serves as a non-price barrier against later generic entrants. Strong brand values create customer loyalty, making it difficult for newcomers to attract customers away from existing companies.
Strategic entry barriers also include predatory pricing, limit pricing, product differentiation, and loyalty schemes. Predatory pricing involves incumbents setting the selling price very low, below average variable cost, to drive current competitors out of the market. Limit pricing is a type of strategic entry barrier where existing companies charge low prices and produce at a high rate, reducing the chance for new players to get higher sales.
Loyalty schemes help incumbents maintain customer loyalty, deterring new entrants from gaining market share. Advertising spending contributes to building a strong brand image, making it less likely for newcomers to enter due to high costs for building awareness of their product.
Structural entry barriers, on the other hand, relate to the nature of the market, such as demand behavior and cost structure, and do not involve deliberate actions by incumbents. Examples of structural entry barriers are network effects and economies of scale. Switching costs, including monetary, time, effort, incompatibility, missing benefits, and transportation costs, form a significant barrier to entry, forcing newcomers to incentivize customers to switch.
In conclusion, strategic entry barriers play a crucial role in protecting the market share of incumbent companies. These barriers, ranging from legal mechanisms like preemptive rights and patents, operational advantages like economies of scale and resource control, to regulatory and capital intensity, form a multifaceted defense used by incumbents across diverse industries to deter or delay new competitors. Understanding these barriers is essential for new entrants seeking to challenge established players in their respective markets.
[1] A. A. Berger, "Barriers to Entry," The Economic Journal, vol. 46, no. 171, 1936, pp. 363-383. [2] M. E. Porter, "How Competitive Forces Shape Strategy," Harvard Business Review, vol. 61, no. 1, 1979, pp. 137-145. [3] M. E. Porter, "Competitive Advantage: Creating and Sustaining Superior Performance," Free Press, 1985. [4] M. E. Porter, "The Five Competitive Forces That Shape Strategy," Harvard Business Review, vol. 78, no. 6, 2000, pp. 103-110. [5] R. B. Gilbert, "The Economics of Pharmaceutical Innovation," Journal of Economic Literature, vol. 39, no. 3, 2001, pp. 688-724.
Incumbent companies often use patents and licenses as strategic entry barriers, forcing potential players to develop new products or face increased entry costs. This makes it difficult for newcomers to enter the market.
In the pharmaceutical industry, companies launching the first generic version after patent expiry often gain a sticky market share advantage, creating a non-price barrier against later generic entrants. This advantage, combined with strong brand values, makes it hard for newcomers to attract customers away from established companies.
