Barriers to entry


Institution Definition

Barriers to entry are factors which prevent or hinder companies from entering a specific market. Entry barriers may result for instance from a particular market structure (e.g. sunk cost industry, brand loyalty of consumers to existing products) or the behaviour of incumbent firms. It is important to add that governments can also be a source of entry barriers (e.g. through licensing requirements and other regulations). © European Commission

Barriers to entry are factors which prevent or deter the entry of new firms into an industry even when incumbent firms are earning excess profits. There are two broad classes of barriers: structural (or innocent) and strategic. These two classes are also often referred to as economic and behavioural barriers to entry. Structural barriers to entry arise from basic industry characteristics such as technology, costs and demand. There is some debate over what factors constitute relevant structural barriers. The widest definition, that of Joe Bain, suggests that barriers to entry arise from product differentiation, absolute cost advantages of incumbents, and economies of scale. Product differentiation creates advantages for incumbents because entrants must overcome the accumulated brand loyalty of existing products. Absolute cost advantages imply that the entrant will enter with higher unit costs at every rate of output, perhaps because of inferior technology. Scale economies restrict the number of firms which can operate at minimum costs in a market of given size. A narrower definition of structural barriers is given by George Stigler, who suggests that barriers to entry arise only when an entrant must incur costs which incumbents do not bear. This definition excludes scale economies as a barrier. There is some debate as to whether Stigler’s definition includes costs not currently being incurred by incumbents or costs which have never been incurred by incumbents. Other economists would emphasize the importance of sunk costs as a barrier to entry. Since such costs must be incurred by entrants, but have already been borne by incumbents, a barrier to entry is created. In addition, sunk costs reduce the ability to exit and thus impose extra risks on potential entrants. Strategic barriers to entry arise from the behaviour of incumbents. In particular, incumbents may act so as to heighten structural barriers or threaten to retaliate against entrants if they do enter. Such threats must, however, be credible in the sense that incumbents must have an incentive to carry them out if entry does occur. Strategic entry deterrence often involves some kind of pre-emptive behaviour by incumbents. One example is the pre-emption of facilities by which an incumbent over-invests in capacity in order to threaten a price war if entry occurs. Another would be the artificial creation of new brands and products in order to limit the possibility of imitation. This possibility remains subject to considerable debate. It should also be noted that governments can be a source of entry barriers through licensing and other regulations. (...) © OECD