Barriers to entry make it difficult to create a new business in a particular industry. The threat of new entrants is one of Porter's Five Forces, which describes factors that contribute to an industry's competitiveness. The harder it is for new entrants to launch a business, the less competitive that industry is considered. In turn, each existing business enjoys greater profitability due to low competition.
If you want to start a small business or expand your current business into a new industry, it's important to understand potential barriers to entry in order to prevent sinking resources into a venture that proves difficult to launch. You'll uncover common barriers to entry throughout your market research, but it's important to remember that a barrier to entry is just a barrier and not necessarily the end of the road. It may take work, but many types of barriers can be overcome.
1. Startup Costs and Capital
The cost of launching a new business represents a high barrier to entry. A lack of funds will cause your business dreams to stagnate, even if everything else seems poised for perfection. However, if you can overcome this primary barrier to entry and find investors or secure a business loan, you could find yourself in a market with low competition. Perform thorough market research and look out for other barriers to entry in order to determine if this is the case.
2. Saturated Markets With Low Profitability
Sometimes, a barrier to entry is less of a hurdle and more of a red flag. That's certainly the case when considering saturated markets with low profitability. Even if it would be relatively easy for you to start a business selling encyclopedias, it wouldn't be easy to make a profit simply due to the accessibility of free encyclopedias online. The market is saturated with encyclopedic information, and people are unlikely to purchase what they already have.
Other markets get saturated simply due to the life span of a product. For example, virtually every modern home has a refrigerator and a stove. You might have a revolutionary idea for kitchen appliances, but in order to make a sale, you have to wait for those existing products to reach the end of their life span, which will create a new demand among customers.
In short, only a small percentage of the population is in the market for new kitchen appliances at any given point in time. So existing firms make it harder for new firms to flourish: There is simply not enough market share to go around.
If you'd like to enter a saturated market, be prepared to make a long-term investment in your business while you slowly convert the market to your technology or idea.
3. Market Is a Monopoly or Oligopoly
A natural monopoly exists when a type of product can only be purchased from one company because no other companies sell it. An oligopoly is similar in that just two or three companies are in competition with each other with slightly different products. In either scenario, prices can remain high for consumers because of such high competition.
It can be difficult to enter a market dominated by just one or two companies for a variety of reasons, one of which is possible backlash from those corporations. Because competition drives prices lower and affects profitability, corporations enjoying a monopoly or oligopoly will have their eyes wide open for potential copyright disputes, intellectual property infringements or use of proprietary information from new businesses attempting to enter the market.
Another major factor is the strong brand recognition that the companies already enjoy. As a new face on the market, you may struggle to earn the trust of consumers. You'll need to know why people are unhappy with the major players and try to provide a better experience.
Network effect can also make it tough to break in: If an incumbent firm has garnered the benefits already, you would have to get a majority of the market on board to really have an effect. This is much more difficult than starting small with a few customers. The monopolist would also enjoy cost advantages, customer loyalty, vertical integration and supply chain connections that you would not have initial access to.
4. Government Regulations and Policies
Red tape and hoops: Few people like to deal with them, and even fewer can afford to hire a lawyer to do it for them. Even if you get all your proverbial ducks in a row in terms of satisfying license and permit requirements, you may still need to understand industry codes and prepare for inspections. It's a lot to wrap your head around, and the thought alone can deter many would-be business owners.
If you want to enter an industry with government regulations and policies, you should be able to find a copy of all relevant laws online or contact your local chamber of commerce for assistance. It's possible that the government regulations are not as intimidating as you think.
In other cases, you may need to put your business-owning dreams on hold while you acquire proper certifications. For example, if you want to own an electrical company and be your own boss, you'll need a journeyman's license, which can often take five to six years of education and experience.
5. Lack of Connections or Experience
Successfully owning and operating a business involves a learning curve, but sometimes, it's hard to even know where to start when you have no experience whatsoever. You might have a great idea that gets you pumped, but that doesn't mean you automatically know what steps to take to start a new business. That overwhelming feeling can be an entry barrier.
In addition, not having any business connections to help you learn the ropes can trap you in that feeling of intimidation. Even knowing just one successful small-business owner can open the door to your own success. Shadow that person if possible.
What if you don't know any small-business owners? Use online communities to your advantage. You can connect with someone in your local area or simply communicate via email to get tips and advice.
6. Competition Benefits From Economies of Scale
When a company benefits from economies of scale, it means that producing a larger quantity of items drives down the production costs per item. Therefore, if competitors are producing thousands of products for a fraction of the cost of what you're capable of producing, they'll be able to sell their products for a lower price and still enjoy a profit.
Handmade products are an excellent example of this. If you have a talent for knitting sweaters, you might want to start a business selling them. However, because it takes you an entire day to knit one sweater, you need to charge a high amount in order to get a full day's pay. On the other hand, your competitors can produce thousands of similar sweaters per day in a factory, so they can charge a much lower price per sweater to receive a day's profit.
That's not to say there's no market for handmade items, but it's important to understand how economies of scale will affect the price consumers are willing to pay. Whether you make sweaters or produce concrete, an efficiently scaled business will have an opportunity to drive down prices and therefore attract more customers, all while still making a profit.
What Do Barriers to Entry Mean for You?
Once a potential entrant has identified potential barriers to entry, you have to decide if the cards are stacked against you or if it's worth pushing ahead to launch your business. Consider other factors like market demand, market structures and the overall competition in your industry. Only you can ultimately decide which barriers are significant enough to halt your dreams and which have a chance of being overcome. The important thing is to identify barriers and have a plan so that you aren't blindsided as you launch your business.