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