Smith, Gavin --- "Barriers to entry - New businesses" [2008] MonashBusRw 23; (2008) 4(2) Monash Business Review 14

Barriers to entry
New businesses

Gavin Smith

Barriers to entry can prevent a new business from establishing itself. The closer to zero the barrier score is, the easier it is for a new company to enter the industry. The closer to 2, the harder it is. The trend refers to the change in conditions over the coming years that may change this score.

Common barriers

Entry Costs

New entrants often have to invest large, up-front sums of cash to establish the business as a viable competitor to incumbents. For example:

• Economies of scale:

Arise when a new entrant has to spend large sums to produce on a large enough scale in order to compete on price i.e. motor vehicles.

• Capital intensity:

Arises when a new entrant has to spend large sums on capital equipment, or on the establishment of sophisticated, comprehensive business systems/processes i.e. mining, printing, electricity generation.

• Skill intensity:

Arises when there is an insufficient supply of skilled labour and a new entrant has to expend large sums to attract skilled workers i.e. computer software design, and medical and surgical equipment manufacturing.

• Globalisation:

Arises when a new entrant has to spend large sums to establish overseas links, international representation and/or establish a reputation with foreign buyers, suppliers or government bodies i.e. pharmaceuticals.

• Research and development:

Arises when a new entrant has to spend large sums on research and development and/or acquiring technical expertise i.e. pharmaceutical research, scientific/electronic equipment manufacturing, petroleum exploration.

• Distribution network:

Arises when a new entrant has to spend large sums to replicate a comprehensive distribution network i.e. retail banking, publishing.

• Product differentiation:

Arises when a new entrant would have to spend large sums on advertising and/or marketing to establish brand names to overcome significant buyer preferences and/or achieve adequate market penetration. This occurs most commonly in consumer markets i.e. soft drink manufacturing, tobacco manufacturing, soap and detergent manufacturing.

• Intellectual Property:

Exists where the cost for a new entrant to re-develop and copy the intellectual property of an existing player would be prohibitive.

• Technology:

Arises where an operator cannot compete without the assistance of a particular type of technology, where that technology is expensive to acquire. Motor vehicles for instance can no longer be viably produced without the technology associated with production-line assembly.

Table 1 Barriers to entry

Regulation

Industries often have special regulatory or deregulatory issues such as licences, permits, quotas, government or self-imposed regulation. Examples of regulations include:

• Taxi licences: May be a limited number of licences available.

• Chemical storage rules: Compliance can be expensive.

• Quotas of production.

• Export regulations: Such as taxes on unprocessed materials.

• Legislation preventing monopolies and mergers.

• Self-regulation: Such as television stations deciding on the standards of the programs they broadcast.

Operating conditions for SMEs

Table 2 Conditions for SMEs

This table shows the operating conditions for SMEs for 15 sectors in the Australian economy. The most attractive sector is ranked 1. The revenue growth prospects over the next two years for each sector are then ranked alongside the operating conditions rank to show the future potential of these industries once entered.

Note: Operating conditions have been scored by IBISWorld’s risk rating product. Criteria includes the level and trend of barriers to entry; international trade; external assistance, level of competition, industry life cycle stage and revenue volatility.

Trying to marshal the speed of technology change at the forefront of scientific development can be hindered by a number of factors:

An inadequate legal/regulatory environment

Obstacles include the legal definition of patentability, and the number of different agencies involved in the regulation and registration of discoveries. Discoveries can also be hindered by third-party patents that make the use of those patents prohibitively expensive.

Research costs

Industries further down the technology pyramid are able to free-ride on the back of industry research, without providing resources to fund it. Often processes can be synthesized from a variety of discoveries, or generic copies made, which works against first to market developers. Most research and development projects end in failure and investments are never recouped.

Timescale

There are long lead times to the commercial exploitation of a discovery. This means that companies must sink high levels of capital into processes and products that may not even work. This process is particularly hard when dealing with investors that have short-term horizons, or do not understand industry fundamentals.

Public opinion

It is often difficult to carry out experiments without an educated public understanding of the aims of experimentation and the processes necessary to make discoveries, as government funding for work is often influenced by popular opinion. This is particularly important as industry firms rely on large amounts of start-up capital in order to fund research.

Moral/ethical obstacles

The industry receives a significant amount of negative publicity, ranging from opposition to the defence industry to objections towards experimentation on animals. At present, there is a particularly strong political and religious movement against research using embryonic stem cells.

Table 3 Industries by level of technology change

Some industries are at the cutting edge of technology development and/or technology usage. An industry such as biotechnology – along with one or two others – is at the top of the technology pyramid. As the developers of leading-edge technology, the industry requires state-of-the-art equipment for optimum results, marketability and contract retention. Developments in high tech industries feed the equipment and processes used in virtually all other industries further down the pyramid.

Cite this article as

Smith, Gavin. 'Barriers to entry'. Monash Business Review. 2008.; Monash University ePress: Victoria, Australia. http://www.epress.monash.edu.au/. : 14–17. DOI:10.2104/mbr08023

About the author

Gavin Smith

Senior Economist, IBISWorld