New entrants to an industry bring new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment necessary to compete.
When the threat is high, incumbents must hold down their prices or boost investment to deter new competitors.
The threat of entry in an industry depends on the height of entry barriers that arepresent and on the reaction entrants can expect from incumbents. If entry barriers are low and newcomers expect little retaliation from the entrenched competitors, the threat of entry is high and industry proﬁtability is moderated.
Barriers to entry. Entry barriers are advantages that incumbents have relative to new entrants. There are seven major sources:
Supply-side economies ofscale. These economies arise when ﬁ rms that produce at larger volumes enjoy lower costs per unit because they can spread ﬁ xed costs over more units, employ more efﬁ cient technology, or command better terms from suppliers.
Demand-side beneﬁ ts of scale. These beneﬁ ts, also known s network effects, arise in industries where a buyer’s willingness to pay for a company’s product increases withthe number of other buyers who also patronize the company. (online auction participants are attracted to eBay because it offers the most potential trading partners)
Customer switching costs. Switching costs are ﬁxed costs that buyers face when they change suppliers. Such costs may arise because a buyer who switches vendors must, for ex-ample, alter product speciﬁ cations, retrainemployees to use a new product, or modify processes or information systems. (SAP ERPs systems)
Capital requirements. The need to invest large ﬁnancial resources in order to compete can deter new entrants.
Incumbency advantages independent of size. These advantages can stem from such sources as proprietary technology, preferential access to the best raw material sources, preemption of themost favorable geographic locations, established brand identities, or cumulative experience that has allowed incumbents to learn how to produce more efﬁciently.
Unequal access to distribution channels. The more limited the wholesale or retail channels are and the more that existing competitors have tied them up, the tougher entry into an industry will be. Sometimes access to distribution isso high a barrier that new entrants must bypass distribution channels altogether or create their own.
Restrictive government policy. Government policy can hinder or aid new entry directly, as well as amplify (or nullify) the other entry barriers.
Expected retaliation. How potential entrants believe incumbents may react will also inﬂuence their decision to enter or stay out ofan industry.
Newcomers are likely to fear expected retaliation if:
* Incumbents have previously responded vigorously to new entrants.
* Incumbents possess substantial resources to ﬁ ght back, including excess cash and unused borrowing power, available productive capacity, or clout with distribution channels and customers.
* An analysis of barriers to entry and expected retaliationis obviously crucial for any company contemplating entry into a new industry.
2. THE POWER OF SUPPLIERS.
Powerful suppliers capture more of the value for themselves by charging higher prices, limiting quality or services, or shifting costs to industry participants. (Microsoft, for instance, has contributed to the erosion of proﬁtability among personal computer makers by raising priceson operating systems.
A supplier group is powerful if:
* When switching costs are high, industry participants ﬁ nd it hard to play suppliers off against one another. (Note that suppliers may have switching costs as well. This limits their power.)
* Suppliers offer products that are differentiated. (pharmaceutical companies)
* There is no substitute for what the...