This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.
As a barrier to market entry we can assume any factor that make it difficult for new firms to enter a specific industry. For example, in the case of an industry that requires large investments from the entrants in capital equipment (e.g. car industry), or the leading firms have built brand loyalties with their customers, then it is difficult for new entrants to overpower them.
The barriers to entry in an industry include the nature of existing competition, the subsistent relationships between suppliers and buyers, and the level in which a product is substitute to another. It is crucial, especially for small new firms, to point out the importance of these factors so as to rival effectively and equally.
How likely it is for an existing firm to face new competitors is relying on the level of the difficulty of entry that this industry presents. In industries that are supposed to be less easy to enter, the competitive advantages outlast, and firms appear to become more efficient regarding to production because of the existing competition. Two factors make it easy for a firm to enter into an industry: the potential reaction of competition and the barriers to market entry that each industry has established.
In this point it is worth mentioning the six sources of barriers to the entry in a market that Porter (1980) identified:
Economies of scale consists the first source of barrier, and they appear when the unit production cost decreases while production volume increases. In this situation, when economies of scale for the leading firms in an industry have already been achieved, it is difficult for new entrants to overpass and compete with each other.
Product differentiation for a firm comes as a result of long-scale advertising and high quality customer service. Gradually, this generates brand loyalty and brand identification. All these create a barrier to industry entry by compelling new firms to consume their budget so as to cope with the need of advertising.
The capital requirements are the most well known barrier to market entry since it may be connected with the need of a production plant or other production facilities. Capital requirements consist one of the stronger barriers due to its level of finance risk that it involves.
Switching costs refer to a unique and short-time kind of cost as a result of switching between two suppliers' products. High switching costs may cause a satisfying level of entry barrier for existing firms by making potential entrants to find new incentives to persuade consumers for their products.
Existing firms monitor and control the distribution channels in a market by building strong relationships. For a new firm, it is necessary to provide pricing motives like as discounts, promotions e.t.c. so as to overcome this barrier.
Last but not least, government policies can prevent new firms from entering new industries through strict legislation legalization e.t.c.
It is important to say that barriers referred above to an industry entry are changeable and upgradeable. However entry barriers should never be accepted as unsurpassed obstacles. There are possibly many small businesses which can obtain the appropriate resources that will allow them to enter to a new market.
Established firms may be able to use advertising to create a barrier to entry because of a fundamental difference between an established firm and a potential entrant. Consumers are more familiar with an existing brand than a new brand of a product. This may convey a marketing advantage that enables the existing firms to formulate advertising campaigns that reduce the effectiveness of potential entrants' advertising in stimulating sales. A significant reduction in the ability of entrants to attract customers with advertising can slow or stop the entry process. Research in the marketing literature has shown that established firms may have this type of marketing advantage. In addition, the effect is asymmetric - new firms are not able to reduce the ability of established competitors to use advertising to attract sales (Netter, 1983).
If heavy advertising is deployed by existing companies in a market, then consumers' loyalty comes up and the potential entrants find it difficult to enter the market. Necessarily, a firm has to achieve a certain minimum level of advertising or other promotional activity so as to affect consumer behaviour. An existing firm, with a large market share, can disperse that cost of reaching that threshold due to its larger sales volume than a small rival. A small enterprise might aspire to reach in a level that unit promotional cost is not too high. However, the effort may be time consuming having as a result a failure to firm's attempts due to scale economies or high unit advertising costs existing firms have, or due to the establishing of a limit pricing strategy so as retain the entrants growth. (Scherer, 1980).
Degree of product differentiation consist one of the major extrinsic obstacles for an entry. In some cases advertising is designed to influence consumer preferences to specific brands. In these cases, the dominant firms gain an important advantage as the upcoming companies have to invest more in their advertising campaign to win back a share from the market, by substantially increasing the cost of entry.
In the case that a firm gets a large market share of a rapidly growing market by advertising, it will probably grow up. It will also gain market power and be expected to have a higher price-cost margin. However, big firms will profit more than small firms. When a firm earns more simultaneously with increasing its advertising - to sales ratio, then for sure it continues to do so since it's difficult for its competitors to follow such big advertising expenditures. Consequently, barriers to entry begin to appear for a potential entrant (Trefor, 2004).
According to Nelson (1974) the way by which advertising affects demand depends on the consumers' information about the characteristics of the products. The products can be included in two general categories: research goods where consumers are informed about the characteristics of the products before making the purchase and experience goods where consumers appreciate the product only after its use. This classification identifies the way goods are advertised. To increase the sales of research products, advertising should provide accurate information about the product which consumer needs so as to decide before the purchase. On the other hand, at experience goods information is neither available nor valuable for the consumer. These products are taken into consideration before use. In this case, advertising affects the demand of experience goods as consumers believe that the advertised products are better.
Kaldor (1950) first pointed out that advertising affects negatively market structure by altering the shares of companies. Kaldor accepted that advertising increases market concentration and therefore affects adversely competition. Given that the relationship between monopoly power and industrial concentration exists, he found out that advertising decreases social welfare in markets with imperfect competition. The larger the advertising expenses of a business are, the higher the profit margins per unit of selling product. These high profits serve as entry barriers for smaller firms. The result is that companies which were initially successful in advertising will increase their market shares reinvesting their profits to even higher levels of advertising. It is assumed that advertising create product differentiation in comparison to that mechanism. Product differentiation leads to a branded product having fixed demand and gaining consumers' trustiness. However, the inelastic demand of the product allows the company to increase its profits by increasing the price without any significant drop in sales. This clearly helps in the prevalence of high market prices and therefore at high monopoly power, which has a negative impact on social welfare.
On the other hand, Bain (1956) argued that the impact of advertising is based on psychological influence that acts on consumers by altering their preferences or simply by strengthening them so that it could not be easily changed. Advertising is based on the power of persuasion that makes consumers buy the advertised product because of its social position, trend or prestige. Galbraith argued that advertising does not affect only the consumers' habits but creates them as well. This fact results in markets with high concentration, with high prices and high marginal profits.