Barriers to entry are factors that make it costly or difficult for a new entrant or potential competitor to enter into a new market and industry. In other words, these barriers correspond to costs that must be shouldered or factors that must be overcome by a new firm.
Take note that there are several conflicting definitions of barriers to entry. Some define these barriers as a competitive advantage of established firms while others consider such as anything that prevents a new entrant or potential competitor to instantaneously create a firm and enter in a new market and industry.
Nonetheless, this article promotes a more generalized and universal definition—as mentioned in the introduction. The subsequent discussion lists down and defines different examples of barriers that prevent startups from entering an established market and industry.
Examples of barriers to entry
1. Absolute Cost Advantage: Some established firms have lower cost structure or absolute cost advantages against potential entrants due to their tenure and expertise. The following are three examples of these advantages: (1) superior production and/or processes emerging from experience; (2) control of inputs or factors of production due to exclusive access to resources and capabilities, established management expertise, presence of established workforce, among others; and (3) easy access to funding because an established firm has higher credit rating over new entrants.
2. Brand Loyalty: Brand loyalty corresponds to the preference of consumers for a particular product from an established firm. A firm creates brand loyalty through tenure, introduction of high quality or innovative products, patent, excellent after-sales and value-added services, and/or continuous advertising and marketing efforts. As an example of a barrier to entry, brand loyalty can discourage potential entrants because it compels them to spend heavily on marketing and promotional efforts. The Coca-Cola Company and Apple Inc. are examples of established firms with a loyal consumer base.
3. Distribution Arrangements: Exclusive agreements between a manufacturer and retailers or resellers can make it difficult for a potential competitor to enter a specific market and industry. This is especially true for small businesses competing against large and established corporations. Examples of these are exclusive agreements between a clothing company and a large chain of department stores, or between a beverage producer and a large fast-food chain.
4. Economies of Scale: Economies of scale is one of the prime examples of barriers to entry. This situation creates a competitive advantage when unit costs become cheaper, thus resulting in a larger output and possible more affordable products. There are several sources of economies of scale, some are: (1) mass production through manufacturing capability; (2) discounts on bulk purchases of raw materials; (3) spreading fixed production cost over large production volume; and (4) less costly advertising and marketing expenditure due to profitability from large production volume. The economies of scale essentially compel potential entrants to operate at the same level as an established firm.
5. Geographical Barriers: Geography or locale serves as an example of a natural barrier to entry. For instance, a country with an abundant supply of a particular natural resource naturally has market dominance. Examples of are oil producing countries such as Saudi Arabia and Iran. Countries with no oil deposits essentially cannot enter the oil market. Another example is prime commercial locations within a city. A commercial space in a prime location can be costly to own or even rent. However, this location is more attractive to the market compared to non-prime location.
6. Government Regulations: Different forms of government intervention through laws and policies create different examples of barriers to entry. For example, zoning allows specific activities in a particular geographic area while excluding others. Regulations in certain industries such as telecommunication and air transportation prevent easy entry from startups. Some jurisdictions require a firm within a particular industry to produce a specified start-up capital. Intellectual property laws, tariffs on imports, and restrictive foreign investment laws are other examples of barriers to entry.
7. Intellectual Property: Different forms of intellectual property, such as patent and trademarks, can correspond to examples of barriers to entry because they can restrict a potential entrant from acquiring and/or using resources or capabilities that can be critical in gaining a competitive momentum. For instance, a patent to a particular technology that gives a company a competitive manufacturing capability will compel a new entrant to develop or acquire its own defining technology. A patented drug owned by a pharmaceutical company prevents a competitor from developing and selling a similar drug.
8. Network Effects: Several products have acquired a large number of critical consumers or users that substituting them from other similar products can either be costly or just plain pointless. Consider the social networking site Facebook as an example. One of the main reasons people choose Facebook over other similar websites is that most of their families and friends use it. Another example is the dominance of iOS and Android mobile operating systems that create barriers to potential mobile operating system developers.
9. Supplier Agreements: Exclusive agreements between suppliers and a company prevent a potential entrant to build a similar supply chain. This is another example of a barrier to entry similar to distribution agreements. Examples include an exclusive agreement between a technology company and different manufacturers of electronic components, or between suppliers of raw materials and a manufacturing company.
10. Switching Costs: Switching costs refer to the amount of time, energy, and money a consumer must spend to switch from an old product or service to a newer one. High switching cost deters a consumer from switching. An example of this is switching from an established computer operating system to an operating system introduced by a startup company. The switch would be costly if the consumer already owns several hardware components and software applications that are compatible with his or her older operating system.
11. Vertical Integration: Vertical integration is an organizational structure in which a firm owns and controls other firms or subsidiaries that form part of its entire value chain. An example is a firm that owns a subsidiary that produces inputs for its production or a subsidiary responsible for distributing its products. Similar with supplier or distribution arrangement, vertical integration gives a firm a competitive advantage, thus deterring potential entrant.
A note on barriers to entry
The aforementioned examples can be considered either as primary barriers or secondary barriers. Primary barriers to entry are the costs and factors that adhere to the traditional definitions. Essentially, these primary barriers correspond to direct costs. Examples of primary barriers to entry are government regulations, distribution and supplier agreements, and intellectual property rights, among others
On the other hand, secondary barriers to entry are the costs or factors that do not directly correspond to actual barriers themselves but reinforce other barriers to entry, specifically the primary barriers to entry. Furthermore, secondary barriers can also arise due to established tenure or industry presence. Examples of secondary barriers to entry are brand loyalty, economies of scale, and network effects, among others.
Remember that a barrier can either be a primary or a secondary depending on the established standards and practices in a particular industry, as well as the situation in a specific market.