Barriers to EntryDefined with Examples & More

Written By:
Adiste Mae

What Are Barriers to Entry?

When a new business is unable to enter a new market or industry sector, the term used to describe the factors that prevent entry in such a scenario is called Barrier to Entry.

When newcomers are prevented from entering the market or industry, it ultimately limits the competition.

Examples of Barriers to Entry include very high startup costs, government regulations, high customer switching costs, strong brand identity, patent protections, customer loyalty, existing firms’ special tax benefits, and other factors that make it too difficult for new businesses to start operating in a new market or industry sector.

From the point of view of existing businesses, barriers to entry assure them that their market share is protected and so will their opportunities to generate revenues and profits. 

Understanding Barriers to Entry

There are several reasons why barriers to entry exist in the market or to a specific industry sector: it could either be due to government regulations or other factors that naturally occur in a free market.

In some cases, companies are protective of the market where their business belongs that they would not allow products of low quality to enter the market and would lobby for the government to create new barriers to entry.

This is also done so that the integrity of the market is protected. 

Several firms benefit from barriers to entry especially if they are already in a position of possessing a considerable market share and want to keep it that way.

Limiting the competition allows them to secure their market share and also their profits. 

Barriers to entry are classified as primary or ancillary.

A primary barrier to entry refers to a cost that presents as a barrier to entry on its own (i.e. high startup costs).

An ancillary barrier to entry cannot be classified as a barrier on its own but when combined with another barrier, it reinforces the other barriers that result in a weak potential entry of a business to a new market or industry.  

Government Barriers to Entry

There are specific industries where the government heavily regulates and naturally places formidable barriers to entry such as commercial airlines, cable companies, and defense contractors due to varying reasons: the government limits air traffic to better monitor and simplify it, cable companies require much of public land use due to their infrastructure requirements. 

There are also cases when the government barriers to entry are not created to limit new businesses but because of the pressures that they receive from existing firms.

An example of this is when businesses, to be able to operate in a state, need to obtain a specific license.

Critics would argue that licensing requirements are not necessary and only limit the competition in the market. 

Natural Barriers to Entry

Some barriers to entry naturally form due to the markets that are monopolistic whereby businesses who attempt to enter it will face extremely high startup costs due to a number of reasons – established firms have lowered costs as compared to a new firm, or existing firms have strong customer loyalty and brand identity that customers of a specific market would prefer them above anyone else. 

For firms that have a strong brand identity, their competition’s products are naturally named after their own brands. Examples of which are Kleenex and Jell-O. 

Firms that have established strong customer loyalty make it difficult for new entrants because of the high-switching cost – the cost they need to incur to convince customers to choose their product over a brand that they already know. 

Industry-Specific Barriers to Entry

Apart from government and natural barriers to entry, there are also industry-specific barriers to entry that originates from the nature of the business or the incumbent’s powerful position. 

Pharmaceutical Industry

The Pharmaceutical Industry, before it reaches the stage of being able to sell a drug to the market, spends years from the time of getting a special authorization to a drug being approved for a prescription.

The whole process takes years and billions of dollars before they can sell.

By the time they do start selling, they will only be able to receive revenue after a decade.  

Electronics Industry

The barrier to entry for the electronics industry is mainly due to economies of scale – large companies who are able to mass-produce are able to distribute their costs across their output thus their ability to price low, whereas small companies who are only able to produce fewer quantities end up providing their products for a higher price. 

The strategy that bigger companies do is to avoid having their customer choose a different provider as in the case of smartphone industries, they charge their customers high switching costs.

For example, Apple makes it impossible for customers to transfer data or software to other devices and produces contracts that are too complicated and costly to terminate. 

Oil and Gas Industry

Making an entry in the oil and gas industry requires high capital for the following: resource ownership, startup costs, environmental and government regulations, patents, copyrights, and operating costs.

Just the fact alone that it has high startup costs is enough reason for smaller companies to back out from exploring this industry, as are the high fixed operating costs.

The government and environmental regulations are also very formidable and even local and foreign governments enforce that regulations be complied with by the business. 

Financial Services Industry

A financial services company can be very expensive to establish.

The most common barriers to entry include high fixed costs and sunk costs associated with wholesale financial services production.

This makes it difficult for smaller companies to compete with larger companies especially if they already have scale efficiencies.

Not only that, the costs related to compliance and possibilities of litigation are enough causes for new companies to enter this industry.

There also exist regulatory barriers between commercial and investment banks and other financial institutions.