Organizations use a range of strategies to create barriers to entry in markets in which they compete including cost, technology, investment, knowledge, customer relationships and switching costs. If entry barriers are high, it is difficult for new competitors to enter a market without major investment and significant risk, whereas markets with low entry barriers allow competitors to enter easily, resulting in more competition and, potentially, more choices for customers.
Low cost production is the most important barrier to new entries in a market, according to a survey in the “Journal of Business & Industrial Marketing.” Organizations in countries with low labor costs, particularly those in emerging economies, can offer prices that high-cost producers find difficult to match.
In market sectors such as technology, large-scale capital investment is essential to develop new products or manufacture them in sufficiently high volume to meet market demands. In the microprocessor industry, for example, new entrants would have to make massive investments to match the high-volume cleanroom environments of existing suppliers.
The technology sector features an entry barrier known as the network effect. According to a paper by Joseph Farrell and Paul Klemperer, organizations spend heavily to build a large base of customers who use compatible products, such as word processing software, to interact with one another. That customer base creates a network that manufacturers of incompatible products would find difficult to enter.
Organizations that hold product patents can prevent market entrants competing directly with similar products. According to the European Generic Medicines Association, patents can have both positive and negative effects on a market. Patents reward and encourage innovation that requires high levels of investment, for example in the development of new medicines; however, organizations can also abuse the patent system to deter competition that might benefit the market in the future.
Where raw materials or other resources are scarce, organizations aim to secure supplies to protect their business and create barriers to market entry. China, for example, supplies the majority of the world’s stock of rare earth metals used in the manufacture of high technology products such as mobile phone handsets. According to “Resource Investing News,” the Chinese Government is taking actions to consolidate the market and build strategic reserves of supplies for its own high-technology industries.
Organizations can use switching costs to protect their most important customers and create barriers to market entry. Switching costs take a number of forms; customers might take out an annual contract for a service but find a lower-priced equivalent partway through the contract, in which case switching suppliers (and breaking their contract) may incur a penalty charge. When organizations train customers’ staff to use their product, customers would face further training costs if they switched to a competitive product.