Ease of Entry: Impact, Influencing Factors

By | Januari 11, 2022

What it is: Ease of entry refers to the difficulty of a company entering an industry or market. It is important because it affects the intensity of competition and profitability in the market. When new entrants come in, they bring in new capacity, increasing supply and lowering market prices. As a result, market profitability declines. 

Conversely, when new entrants are difficult to enter, the pressure on profitability is low. Incumbents may be able to preserve economic profits.

Ease of entry in each market structure

The market structure includes perfect competition and imperfect competition such as monopoly, oligopoly and monopolistic competition. Each has different characteristics of ease of entry.

Under perfect competition, it is easy for new entrants to enter the market. Apart from low barriers to entry, incumbents are also unable to credibly retaliate because of their relatively small size. No company dominates the market.

In addition, the company’s products are also homogeneous. They act as perfect substitutes. It makes customers have no reason to be more loyal to a product over other products. For this reason, newcomers find it easier to attract new customers when they enter.

Under a monopoly market, the market consists of a single producer. Barriers to entry are high for either structural or regulatory reasons. Monopoly markets, such as the electricity industry, have significant capital requirements. Companies spend a lot of money on expensive capital goods. 

In addition, due to a significant proportion of fixed costs, they must operate at high economies of scale to lower average costs and selling prices. For that reason, the government may only allow one company to operate. That way, consumers can enjoy lower prices as a result of higher economies of scale.

Under oligopoly competition, the barriers to entry are usually high making it difficult for entrants to enter the market. It happens for several reasons:

  • Differentiation makes loyal customers. Therefore, it is difficult for new entrants to divert customers from incumbents, making sales targets unattainable.
  • The incumbent has a strong competitive capacity. They can retaliate if new entrants enter the market. For example, they exploit excess capacity to lower market prices, leaving new entrants operating at a loss.
  • High capital requirements. Some industries such as aircraft manufacturing require significant capital investment to build production facilities.

Under monopolistic competition, barriers to entry are low and firms are free to enter and exit the market. Like perfect competition, the market is made up of many players who are small and relatively equal in size. The company has several market forces, namely through differentiation. However, they are not credible enough to establish barriers to entry or retaliation.

Factors affecting ease of entry into the market

Production technique. Incumbents have efficient production facilities thanks to the experience curve effect and intellectual property protection. New players must acquire equally efficient production technology in order to compete effectively. If they are unable to do so, the market puts them at a disadvantage.

Furthermore, despite having the same technology, the incumbent may operate more efficiently because of the experience curve effect. They have learned a lot about how to maximize production machines and allocate resources accordingly.

Differentiation . Differentiation increases switching costs. Consumers are loyal to incumbent products because they offer unique features and satisfy them. As a result, they are reluctant to switch to new player products.

Switching costs. Trying new products is risky. Consumers spend money but the new product does not satisfy them.

Such factors make it difficult for new entrants to acquire new customers. Finally, they have to sell the product at a low volume. They cannot achieve economies of scale and have to bear high operating costs. That makes it difficult for them to achieve the target profit to recoup the initial investment.

Supply chain dominance . Incumbents may control distribution channels through exclusive agreements with major distributors or retailers. It restricts new entrants from accessing distribution channels. They may build their own network. But, it is an expensive investment.

Such dominance also applies to input supply. Exclusive agreements make it difficult for new entrants to get quality input.

Regulation . It can take many forms such as trade barriers, taxes or zoning. The government may also allow only one company to operate in strategic sectors such as utilities.

Capital requirements. Some industries are capital intensive, such as the oil refining, heavy equipment, and automobile industries. They require significant investment to set up production facilities. Newcomers find it difficult to meet such requirements.

Retaliation . The incumbent threatens newcomers credibly. If they enter, they can employ aggressive strategies such as predatory pricing to make new entrants operate at a loss.

They can also take advantage of excess capacity to increase market supply. That makes prices and profitability fall. Thus, new entrants do not get sufficient profitability to return the initial investment.

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