Threat of Entry:
Factors that Reduce Market Share Potential
for New Entrants
MANEC 387
Economics of Strategy
David J. Bryce
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
The Structure of Industries
Threat of new
Entrants
Bargaining
Power of
Suppliers
Competitive
Rivalry
Threat of
Substitutes
From M. Porter, 1979, “How Competitive Forces Shape Strategy”
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Bargaining
Power of
Customers
Barriers to Entry
• A barrier to entry is any factor that
– Increases the costs born by potential entrants
(relative to incumbents), after they enter the
market
– Decreases the market share potential of entrants
upon entering the industry
– Other factors
• Trade restrictions (tariffs, quotas, voluntary export
restraints, infant industry protection, embargoes)
• Government regulation of industries
• Industry certification boards (CPAs, Actuaries)
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Barriers Limiting Market Share
•
•
•
•
Product differentiation
Advertising/Brand image
Access to distribution
Customer switching costs – exploiting
network externalities
• Expected retaliation
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Branding
• A primary means of erecting a
differentiation barrier is to build “brand
equity”
– Brand equity is represented by cumulative
investments in raising awareness and/or
improving the image of a brand usually
through advertising
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Examples
• Brand as Barrier:
– Intel Inside campaign
• Rapid Brand Building for a New Entrant:
– AstraZeneca’s “Purple Pill” campaign
– AZ (re)entered the market for heartburn
therapy with a major effort to build brand
equity
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Access to Distribution
• Examples:
– Coke and Pepsi access to bottlers and
distribution to outlets (economies of scale
in bottling)
– Ready-to-eat cereal in getting and
allocating scarce shelf space.
– Energizer just entered the razor market.
Why?
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Networks and Network Externalities
• Network – a collection of nodes connected by
links
• Externality – the benefits/costs of a decision
are not internalized by the decision-maker
– Negative externalities impose costs on others
– Positive externalities spread benefits on others
• Network externality – positive externality
where the decision to join a network gives
benefit to the existing members of the
network. Value to customer depends on the
number of other customers.
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Economics of Demand in a Network
The nature of demand and dynamic adjustments to
reach equilibrium differ under a network externality.
Network Externality
Price
Price
Traditional Demand
Demand
Supply
Demand
Supply
Q
Dynamic Adjustment
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Q
Dynamic Adjustment
Typology of Network Externalities
• Direct effects
– Telephone networks and fax
– QWERTY
– Internet and E-Bay
• Indirect effects – complementary
networks and “increasing returns”
– Availability of software and service
– Platforms and standards
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Strategies for Network Externalities
How do you become the standard?
•
•
•
•
•
Pricing – IBM vs. Apple
Licensing – VHS vs. Betamax
Alliances – Sony, Philips, and the Compact Disk
Pre-emption – Osborne, Japan and HDTV
Other examples – Netscape vs. Explorer
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Strategic Implications of
Network Externalities
• A product with increasing returns is so
difficult to displace that its competitive
advantage may be insurmountable.
– Lock-in through increased switching costs
– First-mover advantages imply that even a brief
head start may be critical (time matters)
– Inferior technologies may persist (history matters)
• To replace a standard, the value of a new
product must exceed the combined value of
the entrenched product and its network.
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Overcoming Barriers to Entry
• Existing firms in other industries can leverage
their capabilities as a platform for entry
(economies of scale, knowledge, funds, brands,
distribution channels)
•
•
•
•
Technological change/Disruptive technologies
Second mover advantages
Changing legal/regulatory environment
Acquire incumbent firms
Costs of entry must be less
than the profits of entry
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
The Logic of Exit
• Short-run: firm produces as long as it covers
marginal cost (MR>MC).
• Long-run: firm ceases production and exits if
it does not expect to cover fixed costs
(MR<ATC).
• Exit reduces supply, price rises, firm profits
rise to zero.
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
The Problem of Barriers to Exit
• Barriers to exit exist when the costs of exit
are greater than the losses of continued
production.
– Book value of assets greater than market value
– Emotional ties to continued operation
– Uncertain demand and high startup costs (real
options)
– Government support of “strategic industries”
• These barriers perpetuate oversupply and
heighten price competition.
• Worse conditions than perfect competition
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002
Barriers to Entry and Sustainability
of Economic Profits
• Without barriers to entry, economic profits will attract
entry that competes profits away.
• Effective barriers need only make the cost of entry
greater than the potential profits or impose restrictions
that limit market share and thus business viability
• Incumbents are concerned with whether barriers are
high enough to protect current market structure.
• Potential entrants are concerned with how they can
overcome entry barriers and still have other potential
entrants deterred.
David J. Bryce © 1996-2002
Some portions adapted from Baye © 2002