| What are some smaller factors affecting market entry? | 1. Natural limitations - geography
2. (Natural)(state) monopolies (EMS)
3. Patents
4. Checklist for startups: Many dimensions |
| What is a barrier of entry? | Barriers to entry is an economics and business term describing factors that can prevent or impede newcomers into a market or industry sector, and so limit competition. These can include high start-up costs, regulatory hurdles, or other obstacles that prevent new competitors from easily entering a business sector. |
| What is the classification of entry barriers according to Bain, and what does Chicago school think? | Definition of entry barriers:
Entry barriers are defined in many ways but namely:
” Conditions that allow firms to earn abnormal profits without attracting entry of new competitors” - Bain 1956
Chicago school opposes this view: cost differentials above rarely last in the long run not entry barriers per se important BUT the speed at which barriers can be overcome. |
| What are the 3 classic entry barriers according to Bain (1956) | The classic entry barriers consist of:
1. Economies of scale: shape of LRAC and location of MES
2. Absolute cost advantage in producing existing product
3. Product differentiation |
| Why is economies of scale, the shape of LRAC and location of MES a barrier of entry? | If MES is very large relative to total market output, firm must get a big market share to be able to produce at MES most extreme case when LRAC is always decreasing for all possible output sizes: natural monopoly.
Hence, if new firms want to enter the market they will already be at a disadvantage as they are not able to capture enough market share hence their LRAC will be too high, and they will not be able to compete as they produce below MES. The costs for output below MES are substantially higher than output at MES. |
| Why is absolute cost advantage a barrier of entry? | Absolute cost advantage relates to the demand curve being outside the LRAC (entrant) curve (See picture)
Reasons why a firm might have absolute cost advantage:
• Experience in the market / experience with production (Learning by doing - cumulative effect)
• Unique, rare, value-generating and not replicable resources (For instance path dependency in reaching lower costs or higher wages)
• Availability of patents (For instance medicine)
• Exclusivity on key input (For instance SAS has better gate access in Copenhagen airport)
• Vertical production linkages / Vertical advantages / knowledge (For instance breweries can share knowledge on advertising, marketing, logistics etc. if they are in the same group)
• Capital /financing conditions (It is often more expensive for new firms to borrow capital as they are higher credit risk. If it is not possible to borrow, then there are capital market entry barriers) Capital market entry barriers are especially evident for entrepreneurs/start-ups.
However, there is also an opposite view to the above that argues the absolute cost advantage is not a bad thing for the market and overall economic welfare:
• The existence of the current cost advantages do not necessarily represent the permanent benefits (remember Chicago school argument)
• Could be very expensive to acquire absolute cost advantages. Especially if the technological development is fast
• Existing companies may pave the way for the new companies, taking the commercial risks and costs, developing technologies etc.
• Not always optimal to be "first-mover '->' coming in second strategy may be optimal? |
| Why is product differentiation an entry barrier? | Product differentiation can act as an effective barrier to entry, customers are often loyal to existing products. This creates additional costs for new companies.
There are high sunk costs for new businesses, for example to advertise themselves. There may be economies of scale to existing companies in advertising.
Product differentiation may for example arise from:
• Research and patents - new, improved, differentiated products
• Service (pre- & post-sale)
• Advertising, creating a brand (necessary to be constantly on top)
• First mover advantage: The company had time to build up an effective customerbase |
| What are the 4 strategic entry barriers? | In general, there are 4 types of strategic entry barriers:
1. Switching costs
2. Network externalities
3. Brand proliferation
4. Signaling commitment
One thing these strategic barriers have in common is to try to lock-in customers to products / services from a certain firm (or group of firms). |
| Why is switching costs a strategic entry barrier? | These relates to costs incurred when a firm must switch supplier, installation costs when changing products / services. These are often seen in technical products (For instance switching IS system) or financial products (switching bank). |
| Why is network externalities a strategic entry barrier? | Network externalities is an economics concept that describes the circumstances where the value of a product or service changes as the number of users increases or decreases. According to the traditional economic theory, as the supply of a product increases the price of the product falls and becomes less valuable. In certain circumstances the opposite might happen, the value of a product or service may rise with the increase in the number of users. This is called the positive network externalities or the network effect. A mobile network is an example where this concept applies. The more users a mobile service provider has the higher its value. The telephone is a classic example where a greater number of users increases the value to each. When a customer purchases a telephone, a positive externality is created. The online social network is another example where the value is increased with each new user. |
| Why is Brand proliferation a strategic entry barrier? | Where a firm flood a market of all kinds of products to fill out all gaps in the market. Hence, there is only a small segment of the market to enter as most is saturated. The consequence for the firm is that it reduces economies of scale and hence the cost disadvantage for new firms is smaller. |
| Why is signaling commitment a strategic entry barrier? | This is a game theoretic argument for strategic entry barrier. Whether there is entry or not depends very much on what entrants expect what incumbent will do (and vice-versa) and then base their optimal decisions on it.
The idea is that if the incumbent has incurred a large sunk investment such as production facilities, the incumbent signals there will be a price war if someone enters the market.
One key assumption (more details below): when there is a price war, incumbent can realize economies of scale due to the sunk investment (for example, has invested in overcapacity, so can adjust output easily with decreasing costs). |
| What are the two pricing strategies, and how do they act as an strategic entry barrier? | 1. Limit pricing (Pre-entry strategy)
2. Predatory pricing (Post-entry strategy)
They are strategic entry barriers as they are placed by the firms already on the market to deter new entrants that increases competition. |
| What is limit pricing? | Limit pricing (LP) is a form of low-price strategy used by an existing company to intimidate potential competitors away. The price is set just low enough, so potential competitors do not expect to recoup their average cost. No matter how much they offer on the market. LP is a pre-entry strategy to prevent potential competitors trying to enter the market. NB: in order limit pricing to work incumbent must have some cost advantage over new entrants (see assumptions below). Further, it usually does not violate competition act.
Assumptions:
1. New entrants assume that incumbents will keep output level at pre-entry level (Zero conjectural variation)
2. There must be cost advantage for incumbent (The big player in the market)
3. Assume perfect information about the demand curve and cost curve
Interpretation of these assumptions: the management of the potential entrant can’t ex ante estimate how much the price will fall ex post, i.e. after entry! The same applies to existing companies in the market – this is important for determining the correct limit price. |
| What is predatory pricing? | PP is a post-entry strategy, which is used to squeeze competitors out of the market by setting its prices lower than average variable costs. With this method incumbent looses profits in the short-run but long-run profits can be maximized, if incumbent subsequently increases its price. Short-run vs. long run. If strategy is not signaling a strong commitment in the short run new attempts of marke penetration by new entrants. |
| What are some smaller factors affecting market entry? | 1. Natural limitations - geography
2. (Natural)(state) monopolies (EMS)
3. Patents
4. Checklist for startups: Many dimensions |
