Whenever new firm enters in an existing operating market, it is seen as a threat to the established firms in that market. New entrants often bring distinct competitive advantages (through their innovation, technological advancement, customer experience enhancement, availability, simplicity, ease of use, low price etc.) with them to make difference in the existing market. This affects the competitive position of the established firms because it may affect their market shares. New entrants may also bring additional resources with them which may force the existing firms to invest more than what was not required before. Altogether the situation becomes difficult for the existing firms if not threatening always and therefore they resort to raising barriers to entry. These barriers are intended to discourage new entrants to enter the operating market. These barriers are discussed below.
1. Economies of Scale: Economies means production of goods at optimized/reduced cost . At scale means, having the capability to produce large volumes (i.e. larger scale). Economies of scale means Capability to produce huge goods at reduced/optimized costs. Firms which operate on a large scale get benefits of lower cost of production because of the economies of scale. Since the new firm normally would start its operation at a smaller scale and therefore will have a relatively higher cost of production, its competitive position in the industry gets adversely affected. This barrier created through large scale of operation is not only applicable for production side but it can be extended to advertising, marketing, distribution, financing, after sales customer service, raw materials, purchasing and Research and Development as well. For example, you would have noticed in durable industry the kind of investments which players like Samsung and LG do on advertising and promotions normally and specially during events like World Cup cricket match. This makes it nearly impossible for any new third player to launch and sustain such intensive and investment driven marketing attack.
2. Learning or Experience Effect: Established firms through their long years of existence in the market learn better ways of achieving efficiency through their lessons learnt. They gain this learning through their experience of doing better things over these years (called experience). As firms continue to produce more, they grow more efficient and this brings them cost benefits. The efficiency levels achieved is an outcome of the experience, which teaches the organization better ways of doing things. This again keeps any new entrant at a disadvantage.
3. Cost Disadvantage Independent of Scale: New entrants may face disadvantages which are independent of the operations. It may be on account of the lack of proprietary product knowledge such as patents, favorable access to raw material, favorable locations, existing plants built and equipped years earlier at lower costs, lower borrowing costs etc.
4. Brand benefits: Buyers are often attached to established brands. Differences in physical or mere perceived value make existing products unique and the new entrants have to tire out to beat such brands and change the mindset of the customers.
5. Capital Requirements: High investments required for a start up in any business is another deterrent for new entrants bringing down the possibility of increased competition.
6. Switching Costs: Switching costs are the expenses (financial or psychological) which a customer incurs in switching from one product to another product. Cases where such an expense is higher, new entrants find it difficult to establish or survive. Such costs may be because of a strong brand association or the comfort level a customer may be enjoying or it may be on account of a particular technology like Windows operating systems which most customers use and therefore will find it inconvenient to switch to a system like LINUX so easily.
7. Access to Distribution Channel: Already established firms will often have strong partnerships with the distribution channels. They often negotiate better deals so that their products are available in the nearby stores to the consumers at the front visible racks of the distribution channel outlets. This can be a barrier for the entrants when accessibility to them is found to be difficult.
In addition to the above, few general entry barriers exist in each industry’s case, for example, regulatory policies, tariffs and international trade restrictions are few such additional factors.