What does ‘barrier to entry’ mean?
The term ‘barrier to entry’ refers to any factor that keeps new businesses from entering the market and competing with existing companies. The more barriers to entry there are in a specific industry, the more challenging it becomes for new players to enter.
If you want more information on this topic, check out the FAQ section below:
Question #1: What is an example of a barrier to entry?
An example of a barrier to entry would be high start up costs. This is exactly why not everyone can just start an airline business on a whim but practically anyone with a steady income can open an online store. The amount of capital required to put up an airline business is astronomically higher than the capital required to start selling products online.
But this is just one example. There are six more sources of barriers to entry to consider:
- Product differentiation
- Economies of scale
- Switching costs
- Government policy
- Cost disadvantages independent of scale
- Access to distribution channels
Product differentiation refers to the ability of a brand to set itself apart from its competitors. In markets where a lot of top-of-mind brands already operate, new players must spend serious marketing and ad money to differentiate themselves and overcome the strong loyalty of consumers to the brands they know and love.
Economies of scale refers to the decrease in the operational costs of businesses as they start increasing the volume of their production. This means that for a new player to compete with existing businesses, they need to either go big right from the get-go, investing significantly more capital up front, or start small but be at a serious cost disadvantage.
Switching costs refer to the one-time cost a consumer has to incur—such as pre-termination fees, equipment upgrades, and training—to be able to switch to the product or service of a new player instead of sticking with the brand they are already using.
Government policy refers to any controls the government has in place—such as import limits and licensing requirements—that could prevent new players from entering the market and competing with established brands.
Cost disadvantages independent of scale refers to things that established businesses have that new players cannot replicate, such as:
- Proprietary technology
- Extensive experience
- A favourable location
- Government subsidies
- Access to raw materials
Finally, access to distribution channels refers to the availability of distribution channels to new players. If existing businesses have control over them, then it would be extremely difficult for new players to come in and compete.
Question #2: Are barriers to entry a good thing?
Barriers to entry are good for established businesses but bad for new players looking to enter the market and compete. It is good for the former because there would be fewer competitors trying to take market share from them. It is bad for new players because it makes getting started so much more challenging.
But barriers to entry can also be bad for customers in industries dominated by one or two companies—especially if those companies are not known for providing good products and services. Fewer competitors means there would be no incentive for these companies to improve.
Question #3: Are barriers to entry always bad for new businesses?
Not at all. If you think about barriers to entry as an investor, the more there are in a certain industry, the higher the potential profits are once you get in—that and the fact that they make it difficult for new players to come in and compete with you.
The goal, then, is not to stay away from industries that have a lot of barriers to entry but to see first if there is a way to overcome the barriers of the industry you want to compete in.