In a competitive market, the threat of potential entry is an important constraint on firms already in the market. Should an incumbent firm increase its price above competitive levels, potential competitors would respond to this opportunity for profit by entering. Competitive entry would force prices down again. High barriers to entry prevent such competitive entry, and so increase incumbent firms’ market power.
A barrier to entry (typically in the long run) is a cost that a new entrant incurs, but that incumbent firms avoid. This cost asymmetry can prevent the potential entrant from competing with the incumbent even if its other costs are exactly the same as the incumbent’s, and both face identical prices. Thus, barriers to entry may prevent entry by otherwise equally efficient competitors.
A barrier to exit is a cost (typically experienced only when exiting the market) that is so prohibitive that it can reduce, or destroy altogether, a firm’s incentives to enter the market in the first place. Therefore, a barrier to exit may pose a barrier to entry as well.
Barriers to entry may arise due to:
- Legal barriers: Prior to liberalization it was common to prohibit entry into telecommunications markets. This is still the case in some countries,
- Economies of scale and scope: For example, in the telecommunications sector, a new facilities-based entrant may have no choice but to start out at a relatively large scale of operations, in order to achieve unit costs close to the incumbent’s,
- High fixed or sunk costs: If an entrant must incur high sunk costs to enter the market, then the entrant must be prepared to absorb those sunk costs in the event that it fails. However, at the time the new carrier is weighing its prospects and incurring sunk costs, the incumbent carrier faces none of the same risks or costs (even if it did so at an earlier point in time). This basic asymmetry in their positions may pose an entry barrier for the prospective new carrier,
- Essential facilities: If an entrant needs access to an essential facility that is controlled by one of its competitors, this creates a barrier to entry. The entrant must incur the cost of purchasing access to the facility — a cost not faced by the firm that owns the essential facility.
RELATED INFORMATION
Market Power
Essential Facilities