In theories of competition in economics, barriers to entry, also known as barrier to entry, are obstacles that make it difficult to enter a given market. The term can refer to hindrances a firm faces in trying to enter a market or industry – such as government regulation, or a large, established firm taking advantage of economies of scale – or those an individual faces in trying to gain entrance to a profession – such as education or licensing requirements.
Every market has some form of entry requirements before a business or industry can begin capitalizing on their services and products. It may not be the first thought on a business owner’s mind as they begin trying to establish themselves, but it can become apparent that there are more obstacles in the way than what was originally expected. High startup costs, competing against established monopolies in the marketplace or other obstacles are barriers to market entry that must be overcome to proceed.
Natural Barriers to Entry
Some natural barriers to entry that a new business may encounter are economies of scale, control of resources, research and development costs and startup costs.
Economies of Scale are difficult to breach as large scale industries have already saturated the market with their name and product. Think of trying to compete against the Roller Blade company with a new inline skate product. Roller Blade has been so dominant in the field that their product has become synonymous with inline skates, making the brand almost inseparable from the product. Entry into the market against such a heavy weight is naturally deterring.
Control of Resources can block out new businesses when the materials necessary to create the product are owned or controlled by the existing businesses. If the materials needed can’t be found while allowing a competitive price for the new product in the market then proceeding is unlikely to succeed.
Research and Development Costs may make it nearly impossible to get a product to market when the necessary tools and information needed to begin making the product are out of reach.
Startup Costs for advertising, infrastructure purchasing and other fixed costs that may not be recoverable if a business leaves the market can prevent new entrants as well.
Government Barriers to Entry
Generally the government unintentionally makes it difficult for new enterprises to gain entry into markets, but due to a myriad of reasons governments have created barriers to entry. Regulations that require strict adherence to safety, public welfare and access to infrastructure can be insurmountable. New food and drugs must gain safe acceptance from the FDA. New airlines must ensure they meet the requirements of the FAA to operate aircraft and ensure pilots are correctly licensed. Utility companies must find ways to operate with the existing infrastructure to supply the business they propose such as telephone, cable and power. Foreign competition is often excluded by the use of import taxes and tariffs. Along with those issues are the big industries that have lobbying power, which have reached political representatives and gotten favorable laws created to ensure new businesses are excluded. Considerations about all of the above and more must be given when new businesses set out to join a market, making it competitive before the business even hopes to open their doors.
Artificial Barriers to Entry
Additionally, there are measures that an incumbent can take to prevent new entrants in the market. Many of these are now considered anti-competitive practices and are not looked upon favorably by the regulators
Predatory pricing occurs when an incumbent cuts prices of the product aggressively to ensure that new entrants will not be profitable at these prices. The incumbent may be profitable due to economies of scale or other cost advantages, or it may have other products or line of businesses that may subsidize the predatory pricing
Collusion within companies is illegal, but does happen from time to time. This occurs when multiple companies come together and agree on a certain code of conduct that ensures that the market remains split among themselves.