Entry and Exit (lect 9 part 1): Entry

=beginning of production and sales by a new firm in a market

How?

By an established firm that is diversifying into a new market

By a brand new firm

Effect

Market shares incumbent firms (firms already in market) decreases

competition intensifies

when enter?

sunk cost of entry < net present value of the post-entry profit stream

sunk cost: ex. range of investments in specialized assets to obtaining government licenses

post-entry profit: Depends on demand and cost conditions as well as post-entry competition

Barriers to entry

Definition (Bain, 1956)

Anything that allows incumbent firms to earn above-normal profits without the threat of entry

Definition (Stigler, 1968)

Cost that must be borne by firms that seek to enter an industry, but is not borne by firms already in the industry

Differences in entry per industry --> barriers to entry

!!Entry barriers reduce the likelihood of entry and affect the returns of both the incumbent and the entrant !!!

Barriers to entry

Structural barriers to entry (natural advantages of incumbent firms

Strategic barriers to entry ( incumbents'actions to deter entry)

Control essential resources (protection by government policy and regulations)

Cost advantages

Marketing advantages

predatory pricing

expanding capacity

Limit pricing

strategic bundling

Bain's typology

markets characterized by

3 possible entry conditions of a market are

structural and strategic barriers to entry

Entry deterring strategies

accomodated entry

deterred entry

Blockaded entry

market conditions

Blockaded entry: Incumbents do not take any action to deter entry --> existing structural barriers are sufficiently effective ex. water utilities

Accomodated entry: Incumbents should not bother to deter entry --> structural barriers to entry may be low and strategic barriers may be ineffective or not cost effective ex. restaurants

Deterred entry: Incumbents deter entry --> startegy to deter enter is (cost-)effective ex. site pre-emption (right of purchasing before others) in retail banking

Entrants vs Incumbents

Differences predominantly in terms of costs:

Sunk costs for incumbents are incremental costs for entrants ex. Shell, BP, Texaco --> already made enormous investments in the past (sunk), entrants have to make these costs step by step (incrementally)

Established relationships with customers and suppliers are not easy to replicate

Learning curve effects ex. gaining experience is time consuming --> international expansion of banks

Switching cost for consumers for incumbents to entrant are often high ex. switch computer programs