Profits and Entry Barriers in Markets Explained

Barriers to entry are factors that prevent or make it difficult for new firms to enter a market.

The nature of entry barriers changes over time, so this is a key area of the course where you can add contextual examples to your notes to aid understanding.

Entry barriers are the hurdles that one or more new challenger firms must overcome to enter a market profitably. Some entry barriers are structural and relate to the cost advantages of existing / established firms. Other barriers are more strategic or legal in nature.

To maintain supernormal profits in the long run, firms must be able to use entry barriers. This is true forbusinesses in monopoly, duopoly and an oligopoly. But it is not the case with monopolistic competition and perfect competition where free entry & exit is assumed.

With a natural monopoly, large internal economies of scale available to the largest firms mean that there is a tendency for one business to dominate the market in the long run. Barriers to entry are very high because of falling long-run average cost.

Product differentiation is regarded as a barrier to entry. Saturating a market with a wide range of similar, branded, differentiated products it makes it harder for a new firm to find a profitable gap in the market. A good example is the market for soft drinks and the fierce battle for retail shelf space!

When entry barriers are high, established firms with market power can continue to earn supernormal (monopoly) profits in the long run and generate higher returns for their shareholders. High entry barriers make a market less contestable.

Are barriers to entry in many markets getting lower?

1. Rise of lean start-ups – breaking into markets with minimum viable products (MVP)
2. Growth of businesses prepared to use disruptive pricing models based on algorithms
3. Viral marketing via social media can cut the marketing costs of attracting new sales (consider the success of businesses such as GymShark, Depop)
4. The sharing economy – many firms now lease equipment / retail space
5. Increased availability of open-source software and sales platforms as such Amazon Web Services reduce costs for smaller businesses
6. Rise of flexible production on demand and mass customization using additive (3D) manufacturing
7. Many new entrants into markets are businesses that have already scaled production in other markets (consider the rise to prominence of Aldi and Lidl in retail grocery)