David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Threat of Entry: Factors that Reduce Market Share Potential for New Entrants MANEC 387

David J. Bryce © 1996-2002Some portions adapted from Baye © 2002David J. Bryce © 1996-2002Some portions adapted from Baye © 2002

Threat of Entry: Factors that Reduce Market Share Potential for New Entrants

Threat of Entry: Factors that Reduce Market Share Potential for New Entrants

MANEC 387MANEC 387

Economics of StrategyEconomics of Strategy

MANEC 387MANEC 387

Economics of StrategyEconomics of Strategy

David J. BryceDavid J. Bryce


The Structure of IndustriesThe Structure of Industries

Competitive Rivalry

Threat of newEntrants

BargainingPower of

Customers

Threat ofSubstitutes

BargainingPower of Suppliers

From M. Porter, 1979, “How Competitive Forces Shape Strategy”


Barriers to EntryBarriers to Entry

• A barrier to entry is any factor that – Increases the costs born by potential

entrants (relative to incumbents), after they enter the market

– Decreases the market share potential of entrants upon entering the industry

– Other factors• Trade restrictions (tariffs, quotas, voluntary export

restraints, infant industry protection, embargoes)• Government regulation of industries• Industry certification boards (CPAs, Actuaries)

• A barrier to entry is any factor that – Increases the costs born by potential

entrants (relative to incumbents), after they enter the market

– Decreases the market share potential of entrants upon entering the industry

– Other factors• Trade restrictions (tariffs, quotas, voluntary export

restraints, infant industry protection, embargoes)• Government regulation of industries• Industry certification boards (CPAs, Actuaries)


Barriers Limiting Market ShareBarriers Limiting Market Share

• Product differentiation• Advertising/Brand image• Access to distribution• Customer switching costs –

exploiting network externalities• Expected retaliation

• Product differentiation• Advertising/Brand image• Access to distribution• Customer switching costs –

exploiting network externalities• Expected retaliation


BrandingBranding

• A primary means of erecting a A primary means of erecting a differentiation barrier is to build differentiation barrier is to build “brand equity”“brand equity”– Brand equity is represented by

cumulative investments in raising awareness and/or improving the image of a brand usually through advertising

• A primary means of erecting a A primary means of erecting a differentiation barrier is to build differentiation barrier is to build “brand equity”“brand equity”– Brand equity is represented by

cumulative investments in raising awareness and/or improving the image of a brand usually through advertising


ExamplesExamples

• Brand as Barrier:Brand as Barrier:– Intel Inside campaign

• Rapid Brand Building for a New Rapid Brand Building for a New Entrant: Entrant: – AstraZeneca’s “Purple Pill” campaign– AZ (re)entered the market for

heartburn therapy with a major effort to build brand equity

• Brand as Barrier:Brand as Barrier:– Intel Inside campaign

• Rapid Brand Building for a New Rapid Brand Building for a New Entrant: Entrant: – AstraZeneca’s “Purple Pill” campaign– AZ (re)entered the market for

heartburn therapy with a major effort to build brand equity



Access to DistributionAccess to Distribution

• Examples: Examples: – Coke and Pepsi access to bottlers and

distribution to outlets (economies of scale in bottling)

– Ready-to-eat cereal in getting and allocating scarce shelf space.

– Energizer just entered the razor market. Why?

• Examples: Examples: – Coke and Pepsi access to bottlers and

distribution to outlets (economies of scale in bottling)

– Ready-to-eat cereal in getting and allocating scarce shelf space.

– Energizer just entered the razor market. Why?


Networks and Network ExternalitiesNetworks and Network Externalities

• Network – a collection of nodes connected by links

• Externality – the benefits/costs of a decision are not internalized by the decision-maker– Negative externalities impose costs on others– Positive externalities spread benefits on others

• Network externality – positive externality where the decision to join a network gives benefit to the existing members of the network. Value to customer depends on the number of other customers.

• Network – a collection of nodes connected by links

• Externality – the benefits/costs of a decision are not internalized by the decision-maker– Negative externalities impose costs on others– Positive externalities spread benefits on others

• Network externality – positive externality where the decision to join a network gives benefit to the existing members of the network. Value to customer depends on the number of other customers.


Economics of Demand in a NetworkEconomics of Demand in a Network

The nature of demand and dynamic adjustments to reach equilibrium differ under a network

externality.

The nature of demand and dynamic adjustments to reach equilibrium differ under a network

externality.

Pri

cePri

ce

Pri

cePri

ce

Demand Demand

Supply Supply

QQ QQ

Dynamic AdjustmentDynamic Adjustment Dynamic AdjustmentDynamic Adjustment

Traditional DemandTraditional Demand Network ExternalityNetwork Externality


Typology of Network ExternalitiesTypology of Network Externalities

• Direct effects– Telephone networks and fax– QWERTY– Internet and E-Bay

• Indirect effects – complementary networks and “increasing returns”– Availability of software and service– Platforms and standards

• Direct effects– Telephone networks and fax– QWERTY– Internet and E-Bay

• Indirect effects – complementary networks and “increasing returns”– Availability of software and service– Platforms and standards


• Pricing – IBM vs. Apple• Licensing – VHS vs. Betamax• Alliances – Sony, Philips, and the Compact

Disk• Pre-emption – Osborne, Japan and HDTV• Other examples – Netscape vs. Explorer

– DIVX vs. DVD

• Pricing – IBM vs. Apple• Licensing – VHS vs. Betamax• Alliances – Sony, Philips, and the Compact

Disk• Pre-emption – Osborne, Japan and HDTV• Other examples – Netscape vs. Explorer

– DIVX vs. DVD

Strategies for Network ExternalitiesHow do you become the standard?

Strategies for Network ExternalitiesHow do you become the standard?


Strategic Implications of Network ExternalitiesStrategic Implications of Network Externalities

• A product with increasing returns is so difficult to displace that its competitive advantage may be insurmountable.– Lock-in through increased switching costs– First-mover advantages imply that even a brief

head start may be critical (time matters)– Inferior technologies may persist (history

matters)

• To replace a standard, the value of a new product must exceed the combined value of the entrenched product and its network.

• A product with increasing returns is so difficult to displace that its competitive advantage may be insurmountable.– Lock-in through increased switching costs– First-mover advantages imply that even a brief

head start may be critical (time matters)– Inferior technologies may persist (history

matters)

• To replace a standard, the value of a new product must exceed the combined value of the entrenched product and its network.


Overcoming Barriers to EntryOvercoming Barriers to Entry

• Existing firms in other industries can leverage their capabilities as a platform for entry (economies of scale, knowledge, funds, brands, distribution channels)

• Technological change/Disruptive technologies

• Second mover advantages• Changing legal/regulatory environment• Acquire incumbent firms

• Existing firms in other industries can leverage their capabilities as a platform for entry (economies of scale, knowledge, funds, brands, distribution channels)

• Technological change/Disruptive technologies

• Second mover advantages• Changing legal/regulatory environment• Acquire incumbent firms

Costs of entry must be less than the profits of entry

Costs of entry must be less than the profits of entry


The Logic of ExitThe Logic of Exit

• Short-run: firm produces as long as it covers marginal cost (MR>MC).

• Long-run: firm ceases production and exits if it does not expect to cover fixed costs (MR<ATC).

• Exit reduces supply, price rises, firm profits rise to zero.

• Short-run: firm produces as long as it covers marginal cost (MR>MC).

• Long-run: firm ceases production and exits if it does not expect to cover fixed costs (MR<ATC).

• Exit reduces supply, price rises, firm profits rise to zero.


The Problem of Barriers to ExitThe Problem of Barriers to Exit• Barriers to exit exist when the costs of exit

are greater than the losses of continued production.– Book value of assets greater than market value– Emotional ties to continued operation– Uncertain demand and high startup costs (real

options)– Government support of “strategic industries”

• These barriers perpetuate oversupply and heighten price competition.

• Worse conditions than perfect competition

• Barriers to exit exist when the costs of exit are greater than the losses of continued production.– Book value of assets greater than market value– Emotional ties to continued operation– Uncertain demand and high startup costs (real

options)– Government support of “strategic industries”

• These barriers perpetuate oversupply and heighten price competition.

• Worse conditions than perfect competition


Barriers to Entry and Sustainability of Economic Profits

Barriers to Entry and Sustainability of Economic Profits

• Without barriers to entry, economic profits will attract entry that competes profits away.

• Effective barriers need only make the cost of entry greater than the potential profits or impose restrictions that limit market share and thus business viability

• Incumbents are concerned with whether barriers are high enough to protect current market structure.

• Potential entrants are concerned with how they can overcome entry barriers and still have other potential entrants deterred.

• Without barriers to entry, economic profits will attract entry that competes profits away.

• Effective barriers need only make the cost of entry greater than the potential profits or impose restrictions that limit market share and thus business viability

• Incumbents are concerned with whether barriers are high enough to protect current market structure.

• Potential entrants are concerned with how they can overcome entry barriers and still have other potential entrants deterred.

Documents

David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Threat of Entry: Factors that Reduce Market Share Potential for New Entrants MANEC 387