barriers to entry
Barriers to entry are designed to block potential entrants from entering a market profitably. They seek to protect the monopoly power of existing (incumbent) firms in an industry and therefore maintain supernormal (monopoly) profits in the long run. Barriers to entry have the effect of making a market less contestable
The economist Joseph Stigler defined an entry barrier as "A cost of producing (at some or every rate of output) which must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry"
This emphasises the asymmetry in costs between the incumbent firm (already inside the market) and the potential entrant. If the existing businesses have managed to exploit some of the economies of scale that are available to firms in a particular industry, they have developed a cost advantage over potential entrants. They might use this advantage to cut prices if and when new suppliers enter the market, moving away from short run profit maximisation objectives - but designed to inflict losses on new firms and protect their market position in the long run.
EXAMPLES OF BARRIERS TO ENTRY
Patents
Giving the firm the legal protection to produce a patented product for a number of years (see below)
Limit Pricing
Firms may adopt predatory pricing policies by lowering prices to a level that would force any new entrants to operate at a loss
Cost advantages
Lower costs, perhaps through experience of being in the market for some time, allows the existing monopolist to cut prices and win price wars
Advertising and marketing
Developing consumer loyalty by establishing branded products can make successful entry into the market by new firms much more expensive. This is particularly important in markets such as cosmetics, confectionery and the motor car industry.
Research and Development expenditure
Heavy spending on research and development can act as a strong deterrent to potential entrants to an industry. Clearly much R&D spending goes on developing new products (see patents above) but there are also important spill-over effects which allow firms to improve their production processes and reduce unit costs. This makes the existing firms more competitive in the market and gives them a structural advantage over potential rival firms.
Presence of sunk costs
Some industries have very high start-up costs or a high ratio of fixed to variable costs. Some of these costs might be unrecoverable if an entrant opts to leave the market. This acts as a disincentive to enter the industry.
International trade restrictions
Trade restrictions such as tariffs and quotas should also be considered as a barrier to the entry of international competition in protected domestic markets.
Sunk Costs
Sunk Costs are costs that cannot be recovered if a businesses decides to leave an industry Examples include: " Capital inputs that are specific to a particular industry and which have little or no resale value " Money spent on advertising / marketing / research which cannot be carried forward into another market or industry When sunk costs are high, a market becomes less contestable. High sunk costs (including exit costs) act as a barrier to entry of new firms (they risk making huge losses if they decide to leave a market).
A good example of substantial sunk costs occurred in 2001 when British Telecom announced it was scrapping its loss-making joint venture with US telecoms firm AT&T. The closure was estimated to lead to the loss of 2,300 jobs - almost 40% of Concert's workforce. And, it will cost BT $2bn (£1.4bn) in impairment charges and restructuring costs, and AT&T $5.3bn.
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