What are Barriers to Entry?

//What are Barriers to Entry?
What are Barriers to Entry? 2017-10-01T01:57:32+00:00

Definition: Barriers to entry are factors that can delay or prevent the new competitors from entering an existing market or producing a product. Barriers are typical in monopolistic markets making it difficult for competitors to enter or compete in the space.

What Does Barriers to Entry Mean?

What is the definition of barrier to entry? Structural barriers to entry are more related to the market settings such as demand and supply that may create economies of scale, network effects or brand loyalty. Structural barriers are easy to quantify because the cost of increased output that lowers a firm’s average cost (economies of scale) can be quantified.

On the other hand, strategic barriers are related to the behavior of the firms in the market that create these barriers to deter new competitors from entering the market. Some examples include mergers and acquisitions or limit pricing. Strategic barriers cannot be quantified because it is not clear in advance if a firm’s strategic behavior aims to deter entry or to sustain market share. Of course, in most cases, vertical integrationor limit pricing may lead to monopolistic structures.

Let’s look at an example.

Example

A prominent example of economies of scale as a structural barrier is water companies. For the production of tap water, a water company needs to invest in a water supply network to ensure water supply throughout the country. Usually, the cost of water supply network is extremely high as it consists of a drainage basin, a raw water collection point to collect water from a lake or a river, water purification facilities and water storage facilities, further than the water pumping stations, and the pipe network.

However, because a water company distributes water to more than 30 million households, the average cost of producing water is low. If a new competitor wishes to enter the water industry, will their average cost be as low?

The answer is no. Because the water industry is concentrated and has a monopolistic structure, a new firm that will consider entering the industry will face higher costs because its market share will be smaller. Consumers are loyal to the monopoly; therefore, the average costs for a new competitor will be higher than the average costs of the existing water firm.

In this case, economies of scale, monopoly, and brand loyalty, all create structural barriers to entry.

Summary Definition

Define Barriers to Entry: An economic barrier to entry is a roadblock in the market, production process, or supply chain that makes it difficult for new competitors to enter the market and begin competing.