Barriers to entry
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In economics and especially in the theory of competition, barriers to entry are obstacles in the path of a firm which wants to enter a given market.
The term refers to hindrances that an individual may face while trying to gain entrance into a profession or trade. It also, more commonly, refers to hindrances that a firm may face (or even a country) while trying to entering an industry or trade grouping. A common barrier is the required amount of investment especially in industries with economies of scale and/or natural monopolies.
Barriers to entry for firms into a market
Barriers to entry into markets for firms include;- Government regulations may make entry more difficult. Requirements for licenses and permits, for example, may raise the investment needed to enter a market.
- Predatory pricing - the practice of a dominant firm selling at a loss to make competition more difficult for new firms who cannot suffer such losses, as a large dominant firm with large lines of credit or cash reserves can. While this was common in the 19th and early 20th centuries, it is now illegal in most places. See antitrust.
- Patents give a firm the sole legal right to produce a product for a given period of time. Patents are intended to encourage invention and technological progress by offering this financial incentive.
- Economy of scale - Large, experienced firms can generally produce goods at lower costs than small, inexperienced firms. Cost advantages can sometimes be quickly reversed by advances in technology. For example, the development of personal computers has allowed small companies to make use of database and communications technology which was once extremely expensive and only available to large corporations.
- Customer loyalty - large incumbent firms may have existing customers loyal to established products.
- Advertising - incumbent firms can seek to make it difficult for new competitors by spending heavily on advertising that new brands would find it more difficult to afford.
- Research and development - some products, such as microprocessors, require a massive upfront investment in technology which will deter potential entrants.
- Sunk costs - sunk costs cannot be recovered if a firm decides to leave a market; they therefore increase the risk and deter entry.
- Network effect - when a good or service has a value that depends on the number of existing customer, then competing players may have difficulties to enter a market where a strong player has already captured a significant user base.
- Restrictive practices, such as air transport agreements that make it difficult for new airlines to obtain landing slots at some airports.
- Distributor agreements, exclusive agreements with key distributors or retailers can make it difficult for other manufacturers to enter the industry.
- Supplier agreements, exclusive agreements with key links in the supply chain can make it difficult for other manufacturers to enter the industry.
Barriers to entry for individuals into the job market
Examples of barriers restricting individuals from entering a job market include educational, licensing, or quota limits on the number of people who can enter a certain profession such as that of lawyer, and educational, licensing, and experiential requirements for people who wish to be neurosurgeons.Whilst both types of barriers to entry attempt to guarantee that people entering those fields are suitably qualified, the barriers to entry also reduce competition. This has the effect of facilitating premium pricing for the services of regulated professions. That is, if just anyone could enter these fields, then the salaries would be expected to be much lower.
Other types of barrier to entry
Countries can encounter barriers to entry e.g. as witnessed by the long delays that some countries have encountered in their applications to join the European Community.See also
- Anti-competitive practices
- Exclusive dealing
- Market power
- Switching barriers (a/k/a switching costs)
Further reading
- R. Preston McAfee, Hugo M. Mialon, and Michael A. Williams (2004), ["What is a barrier to entry?"], American Economic Review - survey of different definitions of barriers to entry used by economists
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