Deterring competitive entry is a key element of strategic thinking. There are two reasons why firms should consider entry deterrence tactics in their overall strategy:
- The firm can earn higher profits as the single entrant (monopolist) in its marketplace, or as a member of a small group (oligopoly) which holds the bulk of the market share.
- The firm wishes to change an entrant’s expectations about the nature of competition within the industry, following entry.
The second point is the one which is more relevant and important for the majority of firms competing in imperfect markets. If a potential entrant’s perception of the nature of competition within the industry is not altered by the strategy, then the strategy is useless.
We can identify the following barriers to entry that firms can consider using in their competitive strategies:
- Sunk costs. Entry can be deterred if the costs of entry are high, or perceived as being high, by a potential entrant.
- Switching costs. Entry will be deterred when the imitation of products and services can be prevented.
- Limit pricing. Entrants are unsure about either the level of demand and the costs to service it.
- Predatory pricing. Entry is deterred when an incumbent has a history of disciplining the industry through tough pricing practices.
- Excess capacity. Entrants may fear excess capacity will be used by an incumbent to drive down prices and margins.
- Limited access. If access to distribution channels is limited, entry is more likely to be deterred.
- Reputation. Strong relationships and linkages with suppliers and customers can deter entry.
- Barriers to production. Exclusive supply arrangements and economies of scale and scope can inhibit entry..