Many obstacles prevent startups from entering a market. “Barrier to entry” (BTE) is an economic term describing legal, technological and market forces that prevent new competition from easily entering a market or industry. A BTE directly benefits existing businesses and affects the level of competition within a market segment. The more expensive — and hence more difficult — it is to gain market share, the harder it is for a startup to break into a market.
Some of the market forces affecting competition:
• Pricing. A large-market, dominant buyer can obtain bulk discounts, effectively making it the low-cost provider. When a company uses steep price cuts to discourage competition, it’s called predatory pricing. In foreign markets, price dumping is a BTE. Artificially low pricing preserves and protects market share.
• A monopoly. A good example is the AT&T monopoly before its breakup into Baby Bells. Today, Google has a virtual monopoly on internet search, with almost 91 percent market share.
• Vertical integration. Controlling several factors of production can combine to keep costs so low that no one else can compete. For example, a food company that also owns a canning component can sell its products lower than a company without a canning operation. Economies of scale realized from vertical integration result in lower product unit costs, which is an effective BTE.
• Excessive capital-plant and equipment expenses. A good example of this is Elon Musk’s SpaceX. Other than the U.S. government, virtually no one is willing to put up the enormous amount of money needed to venture into space. A highly competitive market would help determine the attractiveness of that market.
• A company’s large advertising budget. Many times, a startup business cannot compete with an incumbent’s long-term marketing program. If successful, the startup must then protect its territory and build its own BTE to thwart new competition.
• Product loyalty. A legacy company’s products may have strong brand identification. Resulting customer loyalty, combined with a history of continued strong market share, serve as an effective BTE.
• Control of natural resources, such as that exercised by the De Beers Group, which controls the worldwide diamond industry. Operating in 35 countries, De Beers mines, retails and sets the prices. No longer a monopoly, it still sells 35 percent of the world’s rough diamond production.
• Government intervention, regulation, contracts and subsidies. Heavily regulated industries are difficult to penetrate. Government regulations can play a role in keeping out new players. The government may act to prevent sub-standard products from entering a market. The airlines are a good example and so are defense contractors and cable companies. Local licensing controls may limit competition. Licensing fees and the scarcity of radio frequencies are examples.
• Tax benefits to existing companies. But companies receiving these benefits are subject to the whim of government changes.
• Intellectual property, such as patents. Production rights may be afforded to competitors at higher rates. A great example of this was the licensing of Casio’s calculator technology rebranded under the Remington Rand name. Although Remington had a strong dealer sales network, Casio was constantly manufacturing new, improved and smaller calculators, undercutting Remington’s pricing. Remington had to regularly discount and dump obsolete products.
• Owning a franchise. A franchisee is instantly part of a greater entity that avails itself of local and national market advertising. Streamlined operating methods and proprietary products add up to additional marketplace efficiencies. Think of Paul Mitchell hair salons and their branded hair-care products.
• An incumbent’s excess cash. Cash can be used to buy strategic competitors or to spend heavily on advertising. Google’s acquisition of YouTube is a great example of this. YouTube is the internet’s second-largest search engine. Google has acquired more than 200 companies, many of which are synergistic and strengthen its other products.
• Marketing tactical changes, such as establishing a subscription model as opposed to a purchase relationship. A good example would be the Dollar Shave Club, which charges a low-cost subscription fee to sell its shaving products by mail. Contrast this with Gillette, the P&G subsidiary and decades-old shaving leader, which recently added a subscription model, Gillette on Demand, in an attempt to compete with Dollar Shave Club. Gillette’s blades typically cost pennies and are marked up over 4,000 percent.
• High switching costs. From the client’s perspective, it is easier to stay with the devil you know. New entrants into a market may have a difficult time convincing a competitor’s loyal customers to change brands. An example is computer equipment and software, which would require substantial expense to change hardware and software and retrain users.
Barriers to entry could be good or bad for your business, depending upon which side of the fence (barrier) you are on.
Dennis Zink is a volunteer, certified mentor and chapter chairman of SCORE Manasota. He is the creator and host of “Been There, Done That! with Dennis Zink,” a nationally syndicated business podcast series. He facilitates CEO roundtables for the Manatee and Venice chambers of commerce, created a MeetUp group, Success Strategies for Business Owners, and is a business consultant. Email him at [email protected]
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