Barrier to Entry

Barriers to entry are the variety of factors that keep new entrants from competing in a particular industry. It may be the strength of the brands of the incumbents. It may be the cost of developing competing technology. It may be access to raw materials or distribution channels. It may even be perceived loyalty of major customers. The equipment needed to manufacture the products may be prohibitively expensive.

Whatever the reason, whether real or imagined, companies must take the factor into consideration when deciding on their strategy. If the cost of competing is too high, they are unlikely to enter the market.

A barrier to entry is generally good for incumbents, but bad for newcomers to the industry.

What keeps Intel and AMD from getting more competition? The tremendous amount of equipment and expertise required to build microprocessors prevents other companies from joining the fray.

In other industries, it may be the high switching costs of the consumer that convinces companies to invest elsewhere. For example, many customers own a great deal of software that runs on the Windows operating system. They may be reluctant to switch from Microsoft software. That makes it more difficult for companies to lure the software giant’s customers away. Even with its rabidly loyal customer base, Apple has made only slow inroads at building market share in the PC sector, with less than 10% of the global share of that pie. Seeing how slow Apple’s progress in the computer market has been has likely been a red flag for other potential competitors.

Occasionally, limited access to distribution channels dissuades new companies. Getting on the shelves at Wal-Mart can make or break a company in some industries. The limited number of competing products the massive chain carries can act to block newcomers.

Barriers to entry may exist at a large scale for national or global brands, or it may be localized. A local fish market may have contracts with the majority of fisherman in an area, limiting the opportunity for others to compete. Real estate prices may have skyrocketed, limiting the ability of new restaurants to afford to build in a particular area.

Lean can change some of the way that barriers to entry are perceived. Steel minimills are a good example of this. Large integrated steel mills were very capital intensive. Small minimills began to emerge which did not have the same capacity but were more efficient (i.e. Lean!) and able to make great inroads into a market that had perceived barriers to entry. Continuous improvement efforts are reshaping the world, and changing the nature of competition in many markets. Internet commerce changed how people could sell their products on a national market. The point is to keep in mind that barriers to entry are temporary in nature and can change quickly when new technology and techniques emerge.

Planned Barriers to Entry

Some companies intentionally erect barriers to entry. It can be through locking up distributors to exclusive contracts. It can be through investing substantially in advertising to make it hard for customers to cut through the noise to find competitors. It can be through buying up patents to block new technology from hitting the market. Some of these techniques do run afoul of the law, but not all planned barriers are illegal.

Or it can be through a Lean strategy that makes the company’s price structure a barrier. The more value you can provide per dollar of cost, the more intimidating you will look to your competition. If they don’t think they can produce at the price points you set, they won’t try to enter the market.

Keep in mind that a Lean strategy is inward facing. An intentional barrier strategy looks outward, which introduces more risk. It is also focused, meaning that it only works in narrow situations. A sizeable investment can be wiped out whenever the market evolves. Lean, on the other hand, is broadly applicable. When customer preferences change, a Lean company’s barrier based on outperforming others can change with the new needs.

Words of Warning About Barriers to Entry

• Barriers to entry can be created and maintained intentionally. Be careful about doing this, as it is a defensive strategy. A single disruptive technology can make all of the investment in building that barrier moot.
• If you want to enter a market, be careful when you analyze barriers to entry. They can easily be estimated incorrectly. Sometimes they look easy to overcome but turn out to be quite challenging. In other cases, though, they look monumental. Lean practices can often break many of the assumptions behind barriers to entry, making the obstacles easier to bypass than they appear.