Barrier to Entry

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Definition of a Barrier to Entry:

A barrier to entry is an obstacle that impedes potential competitors from entering an industry. 

Detailed Explanation:

Barriers to entry limit competition. Barriers to entry may be inherent in an industry (natural barriers to entry), or government imposed (artificial barriers to entry). Every business start-up confronts barriers to entry. Time and money must be invested to produce a good or provide a service. Resources must be employed to market and distribute any good or service. At one extreme is a government mandated monopoly, which forbids other companies from entering the market. In most countries, electrical utilities are owned by the government, and companies are forbidden to compete with them. At the other extreme are companies with minimal start-up costs and a readily available market. A lemonade stand is a business requiring minimal capital and a readily available market.

High start-up costs is the most common barrier to entry. Large investments in plant and equipment may be required to get a business started. This is particularly true when the production process has large economies of scale, meaning a product's average cost decreases as more is produced. New entrants would operate at a cost disadvantage until production is sufficient to take advantage of the economies of scale. It is very difficult to price aggressively when operating at a price disadvantage. Establishing product differentiation or brand loyalty may be another very expensive endeavor. Imagine entering the automobile market. Clearly, a large capital investment is required. There are certainly economies of scale, but perhaps the greatest barrier is brand loyalty. It would take years of extensive marketing for customers to accept the viability of a new make of car. It would take even longer to generate the trust and loyalty required to survive. Other barriers include regulatory restrictions, technological advantages, and access to natural resources. 

Artificial barriers are barriers imposed by government. Government regulation may also act as a hurdle to enter an industry. Licensing and educational requirements restrict the number of professionals in many fields. A company owning a patent creates a barrier since it has the exclusive right to manufacture a good or offer a service. Other companies may be deterred from developing competing products. Government imposed trade barriers such as tariffs, quotas, and subsidies may prove to be too much of a barrier for a company to conduct business in a country.

High barriers to entry benefit a company already in an industry by discouraging competition. Low barriers to entry foster increased competition by increasing the number of sellers. Entrepreneurs may choose to enter a business if they see another company earning a large profit. The Internet has reduced the barriers to entry in many industries. For example, eBay and Amazon have broken geographical barriers by opening markets for many entrepreneurs in areas far from home. 

Barrier to Entry Chart

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