Common/General Barriers to Entry for Small Businesses into the Markets: Township Entrepreneurship

Common/General Barriers to Entry for Small Businesses into the Markets: Township Entrepreneurship A term used in economics and business to describe variables that can deter or make it difficult for newcomers to enter a market or industry sector and so limit competition is “barriers to entry.” These might include prohibitive startup fees, bureaucratic roadblocks, or other barriers that make it difficult for new rivals to enter a market. Existing businesses win from entrance barriers because they preserve their market share and capacity to make money.

Special tax incentives for existing businesses, patent protections, strong brand recognition, devoted consumers, and high switching costs are a few examples of common entrance barriers. New businesses must first get licenses or regulatory approval, among other obstacles.

Understanding Barriers to Entry

While some entrance obstacles are the result of government action, others arise naturally in a free market. Companies frequently ask the government to create new entry barriers. This is ostensibly done to safeguard the integrity of the sector and stop new entrants from flooding the market with subpar goods.

In order to reduce competition and seize a larger market share when they are already well-established in a sector, businesses typically advocate entrance barriers. Other entrance barriers emerge naturally and frequently change over time when dominant firms in an industry take hold. Entry barriers are frequently divided into core and secondary categories.

A major entry barrier appears as a barrier by itself (example: high beginning costs). An ancillary barrier is not in and of itself a barrier. Instead, when paired with other obstacles, it makes it more difficult for the potential company to enter the market. In other words, it strengthens existing obstacles.

Government Barriers to Entry

Industries heavily regulated by the government are usually the most difficult to penetrate. Examples include commercial airlines, defense contractors, and cable companies.123

The government creates formidable barriers to entry for varying reasons. In the case of commercial airlines, not only are regulations stout, but the government limits new entrants to limit air traffic and simplifies monitoring. Cable companies are heavily regulated and limited because their infrastructure requires extensive public land use.

Sometimes the government imposes barriers to entry not by necessity but because of lobbying pressure from existing firms. For example, one state requires government licensing to become a florist and four states require government licensing to become an interior designer.45 Critics assert that regulations on such industries are needless, accomplishing nothing but limiting competition and stifling entrepreneurship.

Natural Barriers to Entry

Barriers to entry can also form naturally as the dynamics of an industry take shape. Brand identity and customer loyalty serve as barriers to entry for potential entrants. Certain brands, such as Kleenex and Jell-O, have identities so strong that their brand names are synonymous with the types of products they manufacture.

High consumer switching costs are barriers to entry as new entrants face difficulty enticing prospective customers to pay the additional money required to make a change/switch.

Industry-Specific Barriers to Entry

Industry sectors also have their own barriers to entry that stem from the nature of the business as well as the position of powerful incumbents.

Pharmaceutical Industry

Before any company can make and market even a generic pharmaceutical drug in the United States, it must be granted a special authorization by the FDA. The FDA cites that even the most important drugs for general public health may take up to six months to approve.6 Although the standard review timeline is around 10 months, more complex drugs or applications may be required to enter this review cycles multiple times due to revisions.7

Moreover, just 18% of applications are approved in the first cycle.8 Each application is incredibly political and even more expensive. In the meantime, established pharmaceutical companies can replicate the product awaiting review and then file a special 180-day market exclusivity patent, which essentially steals the product and creates a temporary monopoly.9

It may take billions of dollars to bring a drug to market. Equally as important, it can take up to 10 years for a drug to be approved for a prescription. Even if a startup company had the capital on hand to develop and test the drug according to FDA rules, it still might not receive revenue for 10 years.10 Last, ultimate success is far from guaranteed. From 2011 to 2020, the likelihood of approval for development candidates for just Phase I was 7.9%.11

Electronics Industry

Consumer electronics with mass popularity are more susceptible to economies of scale and scope as barriers. Economies of scale mean that an established company can easily produce and distribute a few more units of existing products cheaply because overhead costs, such as management and real estate, are spread over a large number of units. A small firm attempting to produce these same few units must divide overhead costs by its relatively small number of units, making each unit very costly to produce.

Established electronics companies, such as Apple (AAPL), may strategically build in switching costs to retain customers. These strategies may include contracts that are costly and complicated to terminate or software and data storage that cannot be transferred to new electronic devices. This is prevalent in the smartphone industry, wherein consumers may pay termination fees and face the cost of reacquiring applications when they consider switching phone service providers.

Oil and Gas Industry

The barriers to entry in the oil and gas sector are extremely strong and include high resource ownership, high startup costs, patents and copyrights in association with proprietary technology, government, and environmental regulations, and high fixed operating costs. High startup costs mean that very few companies even attempt to enter the sector. This lowers potential competition from the start. In addition, proprietary technology forces even those with high startup capital to face an immediate operating disadvantage upon entering the sector.

High fixed operating costs make companies with startup capital wary of entering the sector. Local and foreign governments also force companies within the industry to closely comply with environmental regulations. These regulations often require capital to comply, forcing smaller companies out of the sector.

Financial Services Industry

It is generally very expensive to establish a new financial services company. High fixed costs and large sunk costs in the production of wholesale financial services make it difficult for startups to compete with large firms that have scale efficiencies. Regulatory barriers exist between commercial banks, investment banks, and other institutions and, in many cases, the costs of compliance and threat of litigation are sufficient to deter new products or firms from entering the market.

Compliance and licensure costs are disproportionately damaging to smaller firms. A large-cap financial services provider does not have to allocate as large of a percentage of its resources to ensure it does not run into trouble with the Securities and Exchange Commission (SEC), Truth in Lending Act (TILA), Fair Debt Collection Practices Act (FDCPA), Consumer Financial Protection Bureau (CFPB), Federal Deposit Insurance Corporation (FDIC), or a host of other agencies and laws.121314151

How to Overcome Barriers to Entry

Companies deploy a number of strategies to avoid or overcome barriers to entry. Here are some common barriers and potential solutions to address them.

Trade and Economic Barriers

If governments are employing trade sanctions, it may be more difficult to import or export goods in relation to that country. Companies may seek different markets to work with or seek which products are specifically excluded from trade sanctions. If all else fails, a company may simply delay the timing of transacting with the country with the sanction as many government sanctions are temporary.

Tariffs and Tax Barriers

Companies may pre-emptively decide they want to burden the consumer with additional barrier charges such as import tariffs or taxes. Companies may also seek ways to avoid taxes such as partnering with local organizations to manufacture goods or develop value-added activities in the local market so the imported goods are assessed at a lower value (and assessed lower fees).

Information Barriers

A company seeking to join or create a brand new market may simply not have enough information needed to feel it may be successful. For these types of barriers, it may be best for the company to develop a minimum viable product for market research. This test product may be used to elicit consumer feedback as well as shape financial planning expectations.

A company may also consider acquiring an existing company within the market it seeks to join. Not only will this company have already overcome some if not all aspects of the barriers to entry, the company may have knowledge and information useful to the long-term success of the company.

Market Dominance Barriers

In some cases, the market leader position is so advanced, it’d nearly impossible they’ll be caught in the short-term. For these barriers, companies may consider using a disruptive pricing model and even incurring a short-term loss to steal long-term customers. A company may also set difference objectives such as “be the lowest cost producer”.

Cost Barriers

Though many costs likely can’t be overcome, a company may consider using open-source software instead of custom, proprietary software to cut costs. The company may seek short-term leases instead of capital investments for equipment to gauge financial success in the near term. The company may also choose to only manufacture on-demand or on order to avoid over-committing resources that could have been used elsewhere.

Wrap Up

Many factors of numerous sectors restrict businesses from joining a market. These entry obstacles may be imposed by legislation, developed as a result of prohibitive costs, or arise spontaneously from the nature of the sector. Barriers to entry shield established businesses from quickly being overtaken by rivals for market share. The barriers blocking easy access into an industry will be a bigger obstacle for businesses looking to enter.