Determinants of barriers of entry to potential new entrants into an industry

i. Economies of scale: High fixed costs often imply a high breakeven point, and a high breakeven point depends on a large volume of sales. If the market as a whole is not growing, new entrants into the industry would have to capture a large slice of the market from existing competitors. This is expensive. Thus, if significant scale economies are already enjoyed by existing firms, potential new entrants experience strong barrier to entry into the industry.

ii. Product differentiation: The degree to which existing firms have succeeded in differentiating their respective products or services from the competition determines how strong the barrier to entry for potential new entrants. Existing firms may have built up a good brand image and strong customer loyalty over a long period of time. A few firms may promote a large number of brands to crowd out the competition.

iii. Capital requirements: The amount of capital required to enter an industry determines the extent of difficulty new entrants face in their quest to enter the industry. When investment requirements are high, the barrier against new entrants will be strong, particularly when the investment would possibly be high-risk.

iv. Knowledge requirements: As well as high capital requirements, knowledge and know-how are also a barrier to entry. It is much more difficult to enter an industry which requires significant specialist knowledge, and skills, than an industry where no specialist skills are required.

v. Switching costs: Switching costs refer to the costs that a customer would have to incur by switching from one supplier’s products to another’s. Switching costs is a composite of three costs namely: time, money and convenience. Switching costs are usually higher for industries with greater extent of product differentiation. If switching costs are high, new entrants into the industry experience a strong barrier to entry since they have to invest heavily in differentiating their product and also creating awareness for its products so as to build its own loyal customers. The barrier is even stronger where the market is saturated.

vi. Access to distribution channels: Distribution channels carry a manufacturer’s products to the final consumer. New distribution channels are difficult to establish and existing distribution channels hard to gain access to. Existing distributors are usually reluctant to accept new products to market since they are unsure of their acceptability and patronage by the final consumers. Thus, usually potential new entrants face significant barriers to entry where access to distribution channels is difficult.

vii. Cost advantage of existing producers, independent of economies of scale: Sometimes existing producers in the industry enjoy significant cost advantages which are independent of economies of scale such as patent rights, experience and know-how effects, government subsidies and regulations and favoured access to raw materials. If these advantages are significant for existing producers it contributes to the strength of barrier to entry for new entrants. Existing producers find it easier to engage in price wars to ward of potential new entrants.