Definition and examples of the barriers to entry a new business often faces

What are barriers to entry?

Every runner knows how easy it is to reach your destination when the path is clear and the surface level. But when obstacles are added—say a tree falls after a storm, cutting across the roadway—achieving your goal becomes much more challenging.

For a new business, the roadblocks that make it difficult to succeed are known as barriers to entry. New businesses often face these barriers head-on when entering a competitive marketplace. These barriers include financial obstacles, such as high start-up costs, regulatory hurdles like patent protections, or even consumer pressures, like brand loyalty. Add them together, and they could prove insurmountable: the Bureau of Labor Statistics reports that 45% of all businesses fail within their first five years—in the artificial intelligence industry, that number could be even higher.

Rarely do established businesses roll out the welcome mat for a newcomer—they’re motivated to enact barriers to entry by exerting pressures on the new business in order to limit competition and, thus, protect their market share.

Some industries, like pharmaceuticals, have their own unique set of barriers to entry: In order to produce a new cancer treatment, for instance, a drug manufacturer must spend millions on research, development, and clinical trials. It then needs to gain approval from the U.S. Food and Drug Administration (FDA) so it can produce and sell the drug, which itself is a lengthy process (six months or longer, if revisions are necessary), further adding to their costs.

Related: What Is Disruptive Innovation? Definition & Examples

Examples of barriers to entry in business

A new business can face headwinds at nearly every phase of start-up operations, from securing funding to obtaining licenses, manufacturing products efficiently, and ultimately finding customers willing to give their products a try.

Government barriers to entry

In an ostensibly free market economy, like the U.S., where supply and demand rule the day, the government’s role is to encourage or even offer incentives to new businesses, while at the same time enforcing regulatory oversights to protect consumers. Often, businesses in industries that receive strict regulations have the steepest barriers to entry because they must obtain licensing or regulatory approval in order to operate.

A taxi driver in 2016, for example, had to pay $2,000 in fees and go through a 33-step process in order to be licensed in Washington, DC, which greatly hindered cab companies’ attempts to compete with ride-sharing apps like Uber and Lyft.

In addition, established businesses might receive tax benefits or patent protections from the government, both of which could pose challenges to new businesses.

Competitive barriers to entry

Older businesses could employ strategies that intentionally add barriers to entry, making it difficult for a new business to become established. Through predatory pricing practices, for instance, one business intentionally lowers prices to drive out the competition.

Established businesses considered heavyweights in their respective fields often monopolize resources: Standard Oil controlled 95% of the oil produced in the United States at the turn of the century, and while it took an act of Congress to split it up, its descendants, Chevron  (CVX) – Get Free Report and ExxonMobil  (XOM) – Get Free Report continue to profit from tight capacity and never-ending demand.

Lobbying efforts from business factions can also serve as barriers to entry, as they advocate for more or even stricter government oversight, effectively putting new businesses into a stranglehold.

Operational barriers to entry

The examples discussed above are external to a business, but new businesses also face internal challenges that could serve as barriers to gaining market share. These include:

• High startup costs: The business may need to secure funding from angel investors, through a bank via financing, or even from the general public, which is known as crowdsourcing.
• Economies of scale: It’s not enough for a new business to begin production; it must source resources and establish processes to create products efficiently. Once these are in place, it can roll out greater quantities of products at a lower cost.
• Customer loyalties: It may seem puzzling to list a devoted fanbase as a barrier to entry, but customers can be quite set in their ways. As such, it may take an investment of time, advertising dollars, and incentives, such as discounts or free offers, to persuade buyers to change affinities.

Why are barriers to entry important?

In a perfect world, barriers to entry would not exist. Companies would sell identical products, and every business would have an equal market share.

But this world is far from perfect—in fact, instead of a level playing field, monopolies exist, hogging market share and obstructing opportunity. Think about Amazon  (AMZN) – Get Free Report as a retailer, or Alphabet  (GOOGL) – Get Free Report on the internet. Do monoliths like these always act in the best interest of their customers?

Barriers to entry are therefore challenging but important forces businesses must contend with in a game of survival of the fittest. They maintain industry thresholds of quality and integrity and thus prevent inferior products from coming online.

How can barriers to entry be lowered or reduced?

It all comes down to innovation. When a company produces a product that’s so outstanding that it disrupts business as usual and satisfies the ever-changing needs of consumers—we’re talking tipping point moments like Microsoft’s Windows technology or Edison’s light bulb—barriers to entry can be lowered or even avoided altogether, and the world is never the same.

Get exclusive access to portfolio managers and their proven investing strategies with Real Money Pro. Get started now.

manufacturing
pharmaceuticals
fda
research
clinical trials
sell