Transcript Barriers to Entry - BYU Marriott School

Threat of Entry:
Factors that Increase Cost for New Entrants
MANEC 387
Economics of Strategy
David J. Bryce
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
The Structure of Industries
Threat of new
Entrants
Bargaining
Power of
Suppliers
Competitive
Rivalry
Threat of
Substitutes
From M. Porter, 1979, “How Competitive Forces Shape Strategy”
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Bargaining
Power of
Customers
Entry and Market Structure
• Concentration and product differentiation
determine market structure
• An industry is concentrated when there are
relatively few, powerful firms
• The degree of price competition is directly
proportional to the number of rivals in the
market
• If firms are to earn economic profits in the
long-run, something must prevent entry
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Measuring Industry Concentration
• Industry concentration may be measured as
follows:
– Four firm concentration ratio (C4)
C4  ms1  ms2  ms3  ms4  i 1 msi
4
– Herfindahl-Hirschman index (HHI)
HHI  10,000  i 1 msi2
T
• Limitations: ignores foreign imports (bias
upward), ignores local/regional market power
(bias downward), and industry definitions.
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Concentration in Selected Industries
Industry
C4
HHI
Breakfast Cereals
83
2446
Computers
45
728
Fluid Milk
21
205
Household Appliances
82
2025
Motor Vehicles
82
2506
7
29
Semiconductors
34
414
Soft Drinks
47
800
Snack Foods
63
2619
Tires
73
1814
Ready-mix Concrete
Source: US Bureau of the Census (1997)
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Barriers to Entry
• A barrier to entry is any factor that
– Increases the costs born by potential entrants
(relative to incumbents), after they enter the
market
– Decreases the market share potential of entrants
upon entering the industry
– Other factors
• Trade restrictions (tariffs, quotas, voluntary export
restraints, infant industry protection, embargoes)
• Government regulation of industries
• Industry certification boards (CPAs, Actuaries)
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Barriers that Increase Cost
• Access to capital markets
• Proprietary technology (patents, copyrights,
trade secrets)
• Know-how (knowledge, routines, capabilities)
• Access to raw materials (unanticipated value)
• Geographic locations
• Economies of scale/Learning by doing
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Defining Economies of Scale
• A range of economies of
ATC(Q)
scale exists when average
total cost (ATC) declines as
output rises.
• A range of diseconomies of
scale exists where ATC rises
as output rises.
Econ of
Disecon
Scale
of Scale
• The Minimum efficient scale
(MES) is the smallest output
Q
MES
that can achieve minimum
average cost.
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Sources of Economies and
Diseconomies of Scale
• Economies of scale
– Indivisibility and the spreading of fixed costs –
plant & equipment, overhead, advertising, inventory, R&D
– Increasing efficiency through specialization
• Diseconomies of scale
– Physical limits to efficient size
– Limits to managerial cognition—the cost of
complexity
– Worker motivation
– Distance to suppliers and markets
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Example: Diseconomies of Scale
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Economies of Scale as a
Barrier to Entry
•
•
•
•
Capital costs
Risk and/or inefficient capital markets
Time compression diseconomies
Disproportional marketing costs to achieve
market share equal to MES
• High minimum efficient scale relative to
demand
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Example of High (Relative) MES
as an Entry Barrier
• All firms produce with an
identical technology that
exhibits minimum
efficient scale of four
units.
• How many firms will
enter?
• What will the equilibrium
price and quantity be?
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Price/Cost
10
8
MC(Q)
AC(Q)
6
P(Q)
4
2
2
4
MES
6
8
10
Q
Example of High (Relative) MES
as an Entry Barrier
• Two firms produce at
MES=4
• (Dis)economies of scale
are steeper than demand
and do not justify
producing above MES.
• Other firms would enter
but must produce at MES
• Four more units lowers
price below cost – entry
is deterred
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Price/Cost
10
8
MC(Q)
AC(Q)
P(Q)
6
4
2
2
4
MES
6
8
10
Rents to each firm
Q
Defining Learning by Doing
• Variable cost falls as increasing experience
generates increasing productivity.
• The traditional learning curve is CN = C1 N-l
– Where CN is cost of the Nth unit, C1 is cost of the first unit, N
is cumulative volume (Nth unit), and l is the rate of learning
by doing.
• It is common to assume an 80% learning
curve – every doubling in cumulative output
generates a 20% cost reduction.
– Note that cost falls from $10 to just over $2 after
only 100 units in an 80% curve.
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Learning by Doing as a
Barrier to Entry
• Early entry provides potentially insurmountable
cost advantages
• Learning facilitates fighting the entry of rivals
AVC(Q)
AVC(Q)
AVC(Q)
Too steep
Just Right
Too flat
S Qi
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
S Qi
S Qi
“Strategic Management” of the
Learning Curve
• Win the market share battle
– highest market share has the highest volume and
cumulative volume growing at fastest rate,
descending the learning curve fastest to the
lowest cost.
• Price aggressively to increase volume and
learning
– communicate lowest cost (cost level that will attain)
to marketing to promote sales.
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
“Strategic Management” of the
Learning Curve
• Managing knowledge and learning
– Incentive systems, bonus plans, zero defect
programs, etc.
– Engineering effort (experiments and analysis)
– Teamwork
– Turnover
– R&D practices
– Technology transfer practices
We might concede the market share battle and win the cost war
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Limitations of Strategy on the
Learning Curve
• Market share does not guarantee substantial
cost advantages
– What is the cost of market share?
– Learning curve flattens with high experience
• “Spillovers” leak knowledge to rivals without
full costs of learning
• Short product cycles reduce time to enjoy
cost advantages
• Aging equipment can impede continued
learning and cost advantages
David Bryce © 1996-2002
Some portions adapted from Baye © 2002
Summary and Takeaways
• Barriers to entry increase industry
concentration by raising the cost of entry
above the benefits of entry.
• Barriers to entry are necessary but not
sufficient to ensure firms will avoid price
competition
• When firms overcome entry barriers, they
must worry that they invite others to enter.
David Bryce © 1996-2002
Some portions adapted from Baye © 2002