Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.
What Are the Barriers to Entry
Barriers to entry are obstacles that make it difficult to enter a given market. These hindrances may include government regulation and patents, technology challenges, start-up costs, or education and licensing requirements. Let's discuss a few of the most common barriers.
Types of Barriers to Entry
The government may act as a barrier to entry into a certain market through restrictive licensing requirements or limiting the ability to obtain raw materials. Businesses or individuals looking to start a business in a particular field may be required to get a license or other government approval in order to carry on with business. For example, you may want to start your own radio network but upon further research learn there are several government hurdles and costs to attain and broadcast on a particular radio wavelength.
High start-up costs can keep new firms from entering an industry. Can you imagine trying to get into the car manufacturing business? The amount of capital needed to buy the buildings, machinery, pay the workforce, and so on all serve as a barrier to entry.
Sometimes it is difficult to enter a particular field or business because the technology you need to be successful is protected by a patent. Therefore, you can't use it or are left to try and develop a new technology that may require lots of money to develop.
Economies of Scale
The existence of economies of scale can also be a barrier. Economies of scale are the gains in efficiency and lower production costs that often result from a company growing larger and larger. Since existing firms are already producing, they are often better-positioned to undercut on price. Let's imagine you wanted to start an automobile company. Even if you bought a few buildings, hired a workforce, and obtained the machinery needed, do you think you could produce a similar car at the same cost as Ford, GM, or Toyota?
Product differentiation can be accomplished through strong brand recognition, great customer service, or a network effect. If customers perceive existing products as high quality, then a new business owner will need to spend extra money to educate customers about the unique qualities and benefits of its specific products. The term network effect refers to the situation where a product or service becomes more valuable as more people use it. Examples are Craigslist and eBay. As more buyers and sellers use the site, the websites become more and more valuable to consumers. This makes it extremely difficult to start something that can compete with these websites and lure customers away.
Access to Suppliers and Distribution Channels
When a new business cannot gain access to the needed raw materials, this represents a barrier to entry. Existing companies may have exclusive long-term contracts with key suppliers that will make it difficult for a new entrant to operate in the industry.
If you are looking to start a new business but reasonably expect or fear that existing firms will compete aggressively with you, this may deter you from entering the business. The result of a company's increase in competitive behavior when a new contender enters the market is known as competitive response. Can you imagine trying to open a dollar store in an area that already offers several large-scale dollar store chains nearby? You most likely would be deterred from the fear of how they could put you out of business through aggressive price and marketing tactics.
Examples of Barriers to Entry
Let's look at a few examples of these barriers to entry at work.
The first example is with the telecommunications industry. This is a classic example of where multiple barriers may exist. Successfully competing against telecommunications companies like AT&T, Verizon, and Sprint involves overcoming the huge start-up and capital expense required to build a network. You would also have countless potential government regulations and licensing issues to address. Many of your key competitors might also have a patent on the technology you want to use, further making things difficult. After you solve all of these issues, then you have to address how you will compete with the big established companies on price. Their economies of scale and large networks will give them an advantage in this area.
The second example involves microprocessors for computers. There is a good chance the computer you are using has a chip from Intel or Advanced Micro Devices that helps perform all of the fancy tasks that your computer can do. The large upfront investment in technology, patents, distribution channel issues, and competitive response makes this an incredibly hard industry to break into.
Barriers to entry are obstacles that make it difficult to enter a given market. Government regulations, access to suppliers and distribution channels, start-up costs, technology challenges, economies of scale, product differentiation, and competitive responses are a few of the key barriers that can keep companies from entering an industry. Understanding these economic barriers is critical if you wish to become a competitive force in any industry or field.
Barriers to Entry
|Barriers to Entry|
|Obstacles that make it difficult to enter a market include:
*Access to supplier and distribution channels
*Economies of scale
Watch this lesson and increase your understanding of the above topics so that you can:
- Interpret the meaning of 'barriers to entry' in economics
- List and describe the types of economic barriers
- Provide examples of barriers to entry
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