Barriers to Entry

Question 1

Barriers to entry Vary between Markets

Answer 1

1. A barrier to entry = any potential difficulty or expense a firm might face if it wants to enter a market
2. The ‘height’ of these barriers determines:
   - how long it will take or how expensive it will be for a new entrant to establish itself in a market and increase the amount of competition,
   - whether new entrants can successfully join the market at all.
3. Barriers to entry allow firms that are already in the market (called ‘incumbent’ firms) to make supernormal profits, before new entrants enter the market and compete these profits away. How long incumbent firms can make supernormal profits for depends on:
   - height of the barriers of entry - i.e. how long the barriers can prevent new firms entering the market.
   - the level of supernormal profit being earned - this is because the greater the profits to be made, the more effort new entrants will be willing to make to overcome the barriers.
4. Perfectly competitive markets have no barriers to entry whatsoever.
5. In a pure monopoly market the barriers to entry are total. No new firms can enter, so the monopolist remains the only seller.
6. As usual, in real life the situation often lies somewhere between the extremes of perfect competition and a monopoly. There are some barriers to entry, but they’re not usually total.

Question 2

Barriers to entry can be created in Various Ways

Answer 2

1. Barriers to entry come about for various reasons. For example:
   a) The tendency (innocent or deliberate) of incumbent firms to create or build barriers.
   b) The nature of the industry leading to barriers over which incumbent firms and new entrants have little control.
   c) The extent of government regulation and licensing.

Question 3

Barriers to entry due to incumbent firms’ actions

Answer 3

1. An innovative product or service can give a head start over its rivals which can be difficult for a new entrant to overcome. If the new technology is also patented then other firms can’t simply copy the new design - it’s legally protected.
2. Strong branding means that some products are very well known to consumers. The familiarity of the product often makes it a consumers first choice, and puts new entrants to the market at a disadvantage.
3. A strong brand can be the result of a firm making genuinely better products than the competition, or can be created by effective advertising. The barrier to entry is the expense and difficulty a new entrant to the market would have in attracting the new customers away from market leaders.
4. Aggressive pricing tactics by incumbent firms can drive new competition out of the market before it becomes established. Incumbent firms may be able to lower prices to a level that a new entrant cannot match (e.g. due to economies of scale) and drive them out of business. This is sometimes called ‘predatory pricing’ (or ‘destroyer’ pricing or ‘limit pricing’)
5. Just the threat of a ‘price war’ may be enough to deter new firms from entering a market

Question 4

Barriers to entry can be due to the nature of an industry

Answer 4

1. Some ‘capital-intensive industries require huge amounts of capital expenditure before a firm recieves any revenue. The cost of entering these markets is huge, so smaller enterprises may not be able to break through.
2. If investments can’t be recovered when a firm decides to leave a market, then that may make any attempt to break into a market very risky and unappealing => ‘sunk costs’
3. If there’s a minimum efficient scale of production then any new firms entering the industry on a smaller scale will be operating at a higher point on the average cost curve than established firms. This means any new entrant has higher production costs per unit, so they’d have to sell the product to consumers at a higher price. (see pg 47)

Question 5

Barriers of entry can be due to government regulations

Answer 5

1. If an activity requires a licence, then this restricts the number and speed of entry of new firms coming into a market. E.g. pubs, pharmacists, food outlets, dentists and taxis all require licences before they can operate. Similarly, in a regulated industry firms have to be approved by a regulator before they can carry out certain activities
2. New factories may need planning permission before they can be built.
3. There will also be regulations regarding health and safety and working conditions for employees that firms will need to keep to.

Question 6

New entrants sometimes have their own advantages

Answer 6

1. Not all entrants to a market are small firms trying to compete against established ‘giants’.
2. Sometimes the new entrants can be large successful companies that wish to diversify into a new markets.
3. Their large size means they have greater financial resources, so they may be more successful in breaking into new markets.
   e. g. when virgin money entered the banking sector, their large resources meant they could overcome the barriers to entry - but they had to invest heavily and advertise extensively.