Threat to Entry

Porter states that when barriers to entry are high, the danger of new competition breaking into the market diminishes. The threat from outside competition coming into the market is related to the six barriers to entry in the marketplace: economies of scale, product differentiation, switching costs, access to distribution channels, cost disadvantages independent of scale, and government policy.

Economies of Scale. This barrier is established when market participants can produce a product less expensively than market newcomers. Economies of scale refer to the decrease in unit cost as the volume produced increases. Exhibit 5-3 illustrates the relationship between production level and unit cost. If ABC Corp. is entering the market and chooses to produce 10,000 units, the cost of production is $110 per unit. At a production level of 20,000, the unit cost declines to sixty dollars. The cost advantage of a 20,000-unit production level over a 10,000-unit level is fifty dollars per unit. The significance of economies of scale diminishes as production levels increase. When ABC doubles production from 50,000 to 100,000 units, they would only realize a decline in unit cost of ten dollars, as shown in Exhibit 5-3.

Exhibit 5-3: ABC Corp. unit costs.

The economics of scale issue creates three choices for the newcomer:

Enter the market on a very large scale to be price-competitive. (This requires a significant investment.)

Make a limited investment and operate at a cost disadvantage.

Identify a strategic partner with manufacturing capability and share potential profits.

Product Differentiation. When entering a new market, a company may encounter competitors who have achieved customer loyalty through advertising, customer service, and a prior market presence. It then becomes crucial for the new company to differentiate its product from those of its competitors.

Switching Costs. Entering into new markets may require new supplier relationships. These costs are incurred when changing from one supplier to another. For example, entry into the equipment rental business by an equipment manufacturer may require new inventory-tracking software. The switching costs in this instance are:

Switching Cost	Example
Employee retraining costs	Training employees on new software
Costs of new ancillary equipment	Purchasing new hardware to run the software
Cost in time and system testing	Time expended by the information technology staff
Psychic costs	Staff-related issues around operation of the new software and difficulty with interaction with outside staff

Access to Distribution Channels. Developing distribution channels for new products is difficult and may require special incentives. A distribution channel is a method of getting product to market. For example, in the retail industry, the distribution channel consists of direct sales to your customer (such as the Gateway stores where customers buy PCs directly from Gateway Computers). Established market participants have the advantage of existing platforms to market products. Channel partners, such as distributors, may view existing relationships as less risky. E-commerce has improved access to distribution channels by creating product exchanges and marketplaces. In addition, e-commerce has inherent barriers that are technological and not physical. For example, a company may encounter problems in getting software systems from different companies to interact with one another.

Cost Disadvantages Independent of Scale. Existing competitors also have advantages over new market players that stem from the following four factors:
1. Proprietary product technology such as patents, trademarks, or internal processes. (Viagra is an example here.)
2. Favorable access to raw materials from purchasing agreements with suppliers. (This is a major cost advantage.)
3. Favorable locations that are more accessible to raw materials, or within closer proximity of customers and/or destination. (Hotels located close to beaches or ski slopes are one example.)
4. Better-trained management and staff. (This constitutes a learning or experience curve that has already been traveled.)

Government Policy. The government may create barriers to market entry to assure the welfare of its citizens, or to constrain growth of business. Two policies that serve as obstacles to entering a marketplace are:

Licensing requirements that local governments have enacted. (An example is the licensing requirement for selling alcoholic beverages.)
Limits to access of raw materials. (The paper industry has limited access to national forests constraining logging for environmental purposes.)

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Threat to Entry

Threat to Entry