What is the definition of Barriers to Entry in finance

Definition

Barriers to entry have to do with the difficulties and challenges new companies face when trying to enter certain markets. The challenges could be regulatory challenges, startup costs, licensing, patents, brand identity, customer loyalty, and technical challenges. The more entry barriers new companies face the more market and competitive advantages existing companies have. Barriers to entry may come as a natural occurrence that is difficulties with legal and regulatory bodies, and other formalities required to get into a market. It may also happen as a result of monopoly—existing companies making it difficult for new companies to get into the market.

Understanding Barriers to Entry

As above stated, barriers to entry are the challenges new companies encounter to get into a certain market, and they can occur naturally or artificially.

The naturally occurring barriers to entry are barriers that are naturally expected to arise along the course of establishing a new venture. They can be characterized by;

• High startup costs: to get into specific markets new companies may have to spend a little more than their initial budget to effectively meet the expectations of the market. It is expected of companies to have financial reserves. Startups targeting at meeting market expectations or standards must have large financial reserves as well.

• Exploited economies of scale: economies of scale of a particular market has been fully exploited by existing businesses

• Access to raw materials: A number of new companies face a major challenge in the aspect of acquiring raw materials for their productions. Especially when dealing with scarce commodities.

• Customer loyalty: Building a network of loyal customers may be quite daunting for new companies. Unless extra efforts are being put in to create brand awareness.

The artificial barriers to entry are a product of government influence of monopoly by larger companies seeking to sustain market advantage. They are characterized by;

• Raw materials market monopoly: large companies can decide to acquire a company that distributes raw materials to a specific industry. Having part or full ownership of raw material sources would give these larger companies a competitive advantage over new companies. (See Backward Integration)

• Strong brand identity: Existing companies have been able to build brand identity among the market, thereby, making it difficult for new companies to overthrow strong brands.

• Pricing: Since market prices are determined by the companies involved, new companies may not be able to make profits when certain price limits are indirectly placed by existing companies. The price limits are indirectly set by using a low-price high-output scheme.