External Analysis: Porter’s Five Forces (2/5)
2st Force: Threat of New Entrants
Second force is Threat of New Entrants. When analyzing the threat of new entrants, we assess the barriers that prevent new competitors from entering the market. These barriers may be actively created—such as patents—or may passively arise from factors like economies of scale or customer switching costs.
Understanding these barriers to entry is valuable in business strategy. For established companies, it provides insight into how they can strengthen their competitive position and support long-term sustainability and growth. For new entrants, it helps identify the right markets (e.g., niche markets) to pursue and develop effective strategies for successful entry and positioning.
Barriers to Entry
1. Economies of Scale – The Power of Size
Economies of scale refer to the cost advantages a business gains as production increases, resulting in a lower cost per unit. This happens because fixed costs are spread over more units and operational efficiencies improve with scale. (But if variable costs increase significantly as production increases, overall costs may rise instead. We’re going to explore this subject further in the economics section. See the link at the bottom of the post.)
In many industries, companies produce in optimal volumes (usually quite large) to reduce their production costs. However, new firms often have to start small due to limited capital and a desire to minimize risk. This limits their cost competitiveness, allowing economies of scale to become a significant barrier to entry and giving larger, established firms a strong competitive advantage.
2. The Experience of Existing Companies
The experience of established companies is another key advantage. For instance, airplane manufacturers have mastered efficient design and assembly. This accumulated expertise enables them to lower costs and avoid mistakes—giving them a competitive edge that new entrants cannot easily match.
3. Switching Costs: Making Change Difficult
Switching costs refer to the cost a customer faces when changing from one product, brand, or service to another. These discourage customers from trying new brands or providers. For example, a company using Microsoft Windows may hesitate to switch to another operating system due to concerns about software compatibility and employee habits.
4. Capital and Resource Hurdles
Some industries require significant upfront investment, making it difficult for new entrants to compete. For instance, pharmaceutical companies must invest millions in R&D and navigate strict FDA approval processes. New firms often lack access to the capital, specialized talent, or supplier relationships that established companies already possess—putting them at a disadvantage from the start.
5. Retaliation from Established Firms
In addition to passive barriers, established companies may actively deter new competitors. They might engage in price wars, temporarily slashing prices to squeeze out newcomers. They can use legal tactics, such as filing patent lawsuits to delay or block entry. Or they might launch aggressive marketing campaigns to reinforce customer loyalty. These actions send a strong message: entering this market will not be easy.
Strategic Insight
Creating barriers to entry essentially involves making valuable resources difficult to imitate—a topic we’ll explore further in internal resources.