Barriers to Entry

Barriers to entry are economic hurdles that a new entrant faces while entering that market. In other words, there are the fixed costs that new entrants are liable to pay irrespective of production or sales that may otherwise have not been incurred had the participant not been a new entrant.

Though barriers to entry limit innovation and discourage new firms, it inculcates a sense of responsibility among the aspirants so that they remain competitive if they get into the market.

• Barriers to entry are the economic hurdles new entrants face while entering the market. 
• The types of barriers to entry are capital costs, competition, legal barriers, marketing barriers, limited market, predatory pricing, finding suppliers, master of technology, learning curve, and economies of scale. 
• Barriers to entry aid the monopoly's existence and allow the existing players to enjoy market power and market share. 
• Barriers to entry limit innovation and deter new businesses. Still, by making it difficult to enter the market, they instill a feeling of responsibility in those ready to do so.

Barriers to entry, as the name suggests, are parameters that restrict the entry of any new market player in the existing market. Though it is a good attempt to make sure no unsuitable or undeserving brand enter competition, these hurdles, sometimes, lead to a monopoly in the market.

In a competitive market, the entry of new firms into the industry cuts down the profits and competes away the earnings of the existing players unless the representative firm has just marginal gains. However, this may not be the case in a monopoly market as the monopolist may take advantage of the barriers to entry. Moreover, these barriers prevent the entrants from threatening the player’s profits, as discussed above.

Likewise, in any other market type where existing firms enjoy a market share, an unlimited number of new entrants with new offers and innovations are likely to cause a threat to the stake and the share in profits if there are no barriers to entry. Not only with regards to the existing players, but the government also sets up some regulations and barriers to limit the number of firms in a few industries in the public interest.

Barriers to entry are classified into two broad categories – natural and artificial. While the natural ones are universal restrictions that automatically occur after getting influenced by market factors, the artificial barriers are voluntarily enforced. Here is a list of barriers, both natural and artificial, listed together:

1. Capital Costs – New entrants require investment to run a business in the market. For example, they must buy fixed assets to produce or render services.
2. Competition – The new entrants have to face competition from the market stalwarts. Big wigs pose a severe threat to start-ups by being in the market and enjoying market share.
3. Legal Barriers – The government creates hindrances legally to the new entrants by granting a few exclusive rights, patents, etc., to a few companies.
4. Marketing Barriers – As mentioned about the competition earlier, highly established companies can spend massive amounts on advertisements. In contrast, the new companies may not have the capacity, making it harder for them to show their products.
5. Limited Market – When there are too many players, each company shares a little market only.
6. Predatory Pricing – It may not be straightforward with predatory pricing prevailing in the market.
7. Finding Suppliers – When existing firms have dominant market control, it may be impossible for new entrants to find suppliers.
8. Mastery of Technology – The existing players may be able to control the technology prevailing in the market. On the other hand, the new entrants are usually naïve.
9. Learning Curve – With experience comes learning, and understanding comes speed and perfection. The existing players have this advantage over the new entrants.
10. Economies of Scale – Firms try to have lower production per unit costs to achieve economies of scale.

Let us consider the following barriers to entry examples to understand the concept better:

Example #1

To commence a bank is a huge deal. It requires a lot of legal permits and approvals from the government. Also, a lot of compliances can make entry into the market difficult.

Example #2

Even in industries, like insurance and hospitals, where protecting human lives is the main aspect, barriers to entry exist. This is because it is the government's responsibility to verify if there is proper oversight of the potential entrant to protect life and society's well-being.

Example #3

The vehicle industry usually has strong and dominant players in the market who may have done extensive research about consumer preferences, costs, road conditions, facilities, etc. They might have spent huge amounts on such research to develop the products displayed on the road and achieve the position that the new entrants cannot afford in a short period.

Whether they are high or low barriers to entry, they have significant benefits when it comes to keeping the market quality-oriented and competitive. Let us have a look at some of them:

1. Barriers to entry prevent new entrants from entering the market, producing cheap and inferior products.
2. They protect the existing market players from safeguarding their profits and revenue generation.
3. Barriers to entry help current players concentrate on research and development rather than fighting competition with the new players.
4. The government lays down regulations for players in a few industries like transport to reduce traffic, pollution, etc., telecom industries to reduce heavy infrastructure usage, land, etc.
5. They aid the existence of a monopoly and let the existing players enjoy market power and market share.
6. It gives the players a competitive edge.
7. It is also advantageous to consumers because they can receive high-quality products at lower prices due to the competition.

These low or high barriers to entry also have some risks or limitations, some of which are as follows:

1. High entry costs discourage new entrants to the market, thereby daunting the innovations.
2. Monopoly prevails when new entrants are discouraged, leading to dominance over the consumers.

This article is a guide to what are Barriers To Entry. Here, we use relevant examples to show how they work along with their types, advantages, and disadvantages. You can learn more about excel modeling from the following articles: -

• Hawala
• Examples of Monopolistic Competition
•  Meaning of Perfect Competition
• Perfect Competition vs Monopolistic Competition
• Monopoly vs Monopolistic Competition