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What’s it: Easy of entry refers to the level of difficulty a company has to enter into an industry or market. It is important because it affects the intensity of competition and profitability in the market. When new entrants enter, they bring in new capacity, increase supply, and lower market prices. As a result, market profitability decreases.
Conversely, when new entrants find it difficult to enter, the pressure on profitability is low. Incumbents are likely to be able to preserve economic profit.
Ease of entry in each market structure
The market structure includes perfect competition and imperfect competition such as monopoly, oligopoly, and monopolistic competition. Each of them has different ease of entry characteristics.
Under perfect competition, newcomers easily enter the market. Apart from low entry barriers, incumbents cannot retaliate credibly because of their relatively small size. No company dominates the market.
Also, the company’s products are homogeneous. They act as the perfect substitute. It makes customers have no reason to be more loyal to one product over other products. For this reason, it is easier for newcomers to attract new customers when entering.
Under a monopoly market, the market consists of a single producer. Barriers to entry are high for either structural or regulatory reasons. Monopoly markets, such as the power industry, have significant capital requirements. Companies spend ample money on expensive capital goods.
Also, because of a significant proportion of fixed costs, they must operate at high economies of scale to lower average costs and selling prices. For that reason, the government may only allow one company to operate. That way, consumers can enjoy lower prices as a result of the higher economies of scale.
Under oligopoly competition, entry barriers are usually high, making it difficult for entrants to enter the market. It happens for several reasons:
- Differentiation makes customers loyal. Hence, it is challenging for new entrants to divert customers from the incumbent, making sales targets unattainable.
- Incumbents have a robust competitive capacity. They can retaliate if newcomers enter the market. For example, they take advantage of their excess capacity to lower market prices, leaving new entrants operating at a loss.
- High capital requirements. Some industries, such as aircraft manufacturing, require significant capital investment to build production facilities.
Under monopolistic competition, entry barriers are low, and firms are free to enter and exit markets. Like the perfect competition, the market comprises many players of a small and relatively equal size. The company has some market power, namely through differentiation. However, they are not credible enough to establish barriers to entry or retaliation.
Factors affecting ease of entry to the market
Production technique. Incumbents have efficient production facilities thanks to the effect of the experience curve and intellectual property protection. New players must acquire the same efficient production technology to compete effectively. If they cannot do so, the market places them at a disadvantage.
Furthermore, despite having the same technology, the incumbent may operate more efficiently due to the experience curve effect. They have learned a lot about how to maximize production machines and allocate resources accordingly.
Differentiation. Differentiation increases switching costs. Consumers are loyal to incumbents’ products because they offer unique features and satisfy them. As a result, they are reluctant to switch to new player products.
Switching costs. Trying new products carries risks. Consumers might spend money, but new products don’t satisfy them.
Such factors make it difficult for newcomers to acquire new customers. Finally, they have to sell the product at a low volume. They cannot achieve economies of scale and must incur high operating costs. It makes it difficult for them to reach the target profit to cover the initial investment.
Dominating the supply chain. The incumbent may control the distribution channels through exclusive agreements with the leading distributors or retailers. That limits newcomers to accessing distribution channels. They may build their own network. But it is an expensive investment.
Such dominance also applies to input supplies. Exclusive agreements make it difficult for newcomers to get quality input.
Regulation. It can take many forms, such as trade barriers, taxes, or zoning. The government may also only allow one company to operate in strategic sectors such as utilities.
Capital requirements. Some industries are capital intensive, such as the oil refining, heavy equipment, and automobile industries. They require significant investment to set up production facilities. Newcomers find it challenging to meet such requirements.
Retaliation. The incumbent threatens newcomers credibly. If entered, they can pursue aggressive strategies such as predatory pricing to make new entrants operate at a loss.
They can also take advantage of excess capacity to increase market supply. It makes prices and profitability fall. Thus, new entrants do not obtain sufficient profitability to return the initial investment.
