When starting a new business, or bringing a new product to market, there’s no shortage of factors that affect the odds of potential success. By understanding barriers to entry and how they impact the competitive landscape, new firms can put themselves in a stronger position to compete with existing firms in a given industry.
New entrants in a market will always have an uphill battle to climb especially in the case of high start up costs. Fortunately, for many ecommerce businesses, the natural barriers that often keep new entrants from seeing growth compared to their competition is not a major factor.
In this guide, we’ll cover the basics of barriers to entry and explore how each of the barriers to entry impact business success.
What are barriers to entry?
Barrier to entry is the high cost or other type of barrier that prevents a business startup from entering a market and competing with other businesses. Barriers to entry are frequently discussed in the context of economics and general market research.
How barriers to entry work
Barriers to entry can include government regulations, the need for licenses, and having to compete with a large corporation as a small business startup.
While there is no universally accepted list of barriers to entry, generally barriers to entry fall under three categories.
Artificial barriers to entry: Artificial barriers to entry refers to barriers that are the direct result of existing firms actions. Frequently, this involves barriers centered around pricing, brand, switching costs, and customer loyalty.
Natural barriers to entry: This includes high barriers such as network effects, economics of scale, and other natural barriers that are the direct results of a new entrant’s new position in the marketplace.
Government barriers to entry: Barriers to entry related to the government refer specifically to challenges new firms face as a result of government regulations and restrictions. Governments around the world frequently create favorable conditions for particular incumbent firms that can make it challenging for new entrants.
Examples of barriers to entry
Economies of scale in established companies
A large, established company benefits from producing a high volume of products efficiently, resulting in lower fixed costs. This efficiency allows for more cost-effective operations compared to smaller companies with fewer resources. Large companies achieve lower costs through bulk purchasing and reduced overhead by consolidating production under one roof. In contrast, smaller companies struggle to compete with these economies of scale, sometimes avoiding market entry altogether.
Government-imposed education and licensing requirements present another barrier to entry. For instance, starting an alternative school necessitates substantial investment in various certifications and approvals. This requirement imposes significant capital costs, particularly challenging for new firms with limited cash flow.
Market share and startup costs
Firms with established market share in an industry have a significant advantage over new entrants. New companies face not only high startup costs but also the challenges of business growth. In contrast, existing firms enjoy cost advantages and the benefits of an already established market presence.
Impact on competition and prices
Barriers to entry can negatively impact market competition and pricing. When the playing field is uneven and competition is limited, prices may be unfavorably influenced. This situation often benefits large, monopolistic companies at the expense of new entrants and consumers.
However, barriers to entry are not always completely prohibitive. In fact, many business startups encounter some sort of barrier to entry that they must overcome, whether that’s initial investments, acquiring licenses, or obtaining a patent—it’s just part of doing business.
Sources of barriers to entry
Generally speaking, entry barriers come from seven sources:
- Economies of scale: The decline in the cost of operations due to higher production volume which helps keep fixed costs low. More established existing firms have a significant cost advantage compared to newcomers.
- Product differentiation: The brand strength of the product as a result of effective communication of its benefits to the target market. It can be difficult for new entrants to “break through the noise” in their market.
- Capital requirements: One of the major economic barriers, capital requirements refers to financial resources required for operating the business. Starting a car wash business, for example, is more capital extensive than creating an ecommerce store.
- Switching costs: This refers to one-time costs the buyer must incur for making the switch to a different product. Your product technically may be the better solution, but if the cost to switch is too high, customers often will remain with the solutions existing firms provide.
- Access to distribution channels: Does one business control all of them, or are they open? Shipping, logistics and more are a powerful barrier to entry, incumbent firms use to their advantage.
- Cost disadvantages independent of scale: When a company has advantages that cannot be replicated by the competition, such as proprietary technology.
- Government policy: Controls the government has placed on the market, such as licensing requirements and other required documentation needed to start and grow a business.
Overcoming barriers to entry
Barriers to entry are diverse and multifaceted. Here are some examples of businesses overcoming different barriers to entry:
Strong marketing campaigns
Often, established businesses spend a lot of money on marketing and advertising to differentiate their products, which builds brand recognition and customer loyalty, making new entrants harder to get customers. In many regions, Coca-Cola is synonymous with soft drinks, so newcomers have a hard time getting into the market.
Reducing cost per unit
With economies of scale, larger companies can offer lower prices or better margins by reducing their cost per unit. With its huge distribution network and sales volume, Amazon gets lower prices and faster delivery than smaller retailers.
New entrants can disrupt established markets by offering innovative products, services, or business models. Tesla challenged the dominant position of traditional gasoline-powered car manufacturers when it entered the automobile market with electric vehicles.
Overcoming policy and regulation
Antitrust laws and fair competition regulations are crucial in preventing monopolies and ensuring a level playing field. The European Union’s fines against Google for abusing its market dominance is a reminder of the importance of regulatory oversight in maintaining competitive markets.
Making an impact on the market
By bypassing traditional channels, Warby Parker revolutionized the eyewear industry through offering designer-quality eyewear at lower prices. Its direct-to-consumer model, competitive pricing, and innovative customer engagement strategies have forced traditional eyewear retailers and brands to rethink their strategies.
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Barrier to entry FAQ
What is a barrier to entry?
A barrier to entry refers to any obstacle or difficulty that prevents new competitors from easily entering an industry or area of business. There are lots of barriers to entry, such as high startup costs, strict regulations, strong brand loyalty for existing companies, and access to raw materials and technology.
What are the three barriers to entry?
Barriers to entry generally fall under three categories, artificial, natural, and government. Natural refers to structural barriers to entry, artificial refers to strategic barriers to entry, and government refers to regulation and legal requirements established by governments.
What is a barrier used to prevent entry?
There are many examples of entry barriers in the marketplace. Here are a few.
- Tax benefits given to established companies in a certain industry
- Price reduction by established companies to prevent potential entrants from competing
- Patent protection
- Licenses required by the government to enter a specific market
- Brand loyalty