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Barriers to Entry - What are barriers to entry?

A barrier to entry is something that stops a company entering a new market.

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Barriers to entry that might stop a company can come about for a variety of reasons - criteria that a business has to meet to get up and running (e.g financial, marketing, luring customers away from existing services/ products), or even from the actions of competitors hoping to discourage others from entering the same market.

What are some barriers to entry in an accounting sense?

From a financial and accounting perspective, barriers to entry can be met quite quickly when you take into account all the things you’ll need to consider to get the company up and running.

  • Start-up costs - being too high (e.g. cost of equipment or licenses)

  • Patents – if existing companies within the industry already have patents on certain technologies, then new companies wanting to enter the market will have to come up with something entirely from scratch as they are not allowed to use the existing technology. This leads onto;

  • Research and Development (R&D) – the cost of researching and developing a new technology is in almost all cases astronomically high, and therefore a small or new company will simply not have the resources to begin the process.

What different types of barriers to entry exist?

There are two distinct types of barriers to entry which we’ll take a look at shorty- they are natural barriers to entry, and artificial (sometimes known as “strategic”) barriers to entry. Depending on the industry or service (and the rest of the market), one set of barriers could be more difficult to overcome than the other, but it goes without saying that a new company will have a mixture of both sets of barriers they need to remove.

The size of a business is also something to consider- a larger business may have more potential barriers because they have to take a wider range of things into account. At the same time, they also may have more capital and better resources to overcome barriers much more easily than a smaller business might.

Natural barriers

Natural barriers are what a new company faces when starting their business and attempting to enter a new market. Most commonly they are things such as equipment costs, software licensing costs, or the amount of money needed to invest in resources necessary to run the business and get it off the ground, similar to what has been covered earlier in the article.

Artificial barriers

Artificial barriers are more abstract things, and commonly are something that competing companies within the industry will do in an attempt to deter new and smaller companies from entering the same space. This can be done a variety of ways such as;

  • Marketing / advertising - marketing and advertising costs that help to create and promote your brand and get you in front of customers will be both potentially costly, and will take some time to have an impact- which will in turn generate customer leads and bring in income. Companies with a larger market share might use marketing and advertising to promote how many customers they are trusted by, possibly creating brand loyalty amongst their existing customers.

  • Branding - other companies in the same market (especially if they have a large market share and bigger budgets) can spend more on branding their company in a more thorough way, which means that they will draw a larger amount of customers. It will also help to retain customer numbers that they already have. This relates back to marketing and advertising above.

  • Cost of switching - Depending on what the service or product is, the costs for switching to a new service or product could be quite high. This could either be in the way of specialised software, equipment that pairs with it, or a heft yearly subscription fee for example.

  • Loyalty programs - discounts on monthly fees, or special offers/ rewards may be used to keep a customer with a particular company - something that new companies cannot offer as they will have only just set their pricing structure going forward.

How is it possible to determine barriers to entry?

There are a few different ways of finding out what kind of barriers to entry you might face as a new business. More often than not methods such as a Strengths, Weaknesses, Opportunities, Threats (SWOT) analysis, the Ansoff Matrix, Porter's Five Forces model, or a PESTLE analysis are used and combined to give the best overview of barriers.

In this article, we will be looking at the PESTLE analysis because it looks more defined at first glance, without being overwhelming. PESTLE stands for Political, Economic, Social, Technological, Legal, Environmental. Each situation is different for each company, as well as the particular industry they are looking to start doing business in.

  • Political - government policies can have a huge impact on business in many different ways- new tax policies, regulations about workers rights, and privacy rights for consumers are all examples of things that a government could introduce that affects have a business runs and operates.

  • Economic - all things that affect a company in an economic sense such as the exchange rates (if business is conducted internationally), inflation, tax rate changes, or interest rate changes - all of which could mean having to raise prices for consumers to offset the cost.

  • Social - refers to categories such as income distribution, or population growth. If income distribution is well balanced, then there is a bigger potential market for a product or service to be bought/ used. However, if there is an imbalance, this will mean that the amount of customers that will use the product/ service will be somewhat limited. In the same vein, if population growth is swift, there might be some teething problems with keeping up with demand.

  • Technological - Depending on the industry, especially if the idea is a new product that is going to be brought to market, then it might be necessary to invest in research and development (R&D) in order to make the idea a reality. On the other side, the product has to be simple enough for customers to use, otherwise it will be a flop if customers are not technologically aware enough.

  • Environmental - The environmental aspect of PESTLE can cover complex things such as environmental policies, all the way through to more straight forward aspects such as weather and climate. The weather and climate of a particular region or country can be important if a business is seasonal, as this will set how long during the year they can stay open and operate.

  • Legal - employment laws will dictate how easy things like hiring employees will be, how much needs to be allocated to pay a living wage, sick days etc, and consumer protection laws will shape refund/ return policies, as well as the obligations of the company to resolve customer issues. This can also extend to the type of customer support offered to meet these consumer protections.