Barriers to Entry

What It Means

Barriers to entry include all of the obstacles that discourage and sometimes prevent new companies from entering an area of business. High start-up costs (the money required to open a business) and licensing fees are two of the most effective barriers to entry, especially in the restaurant business. For instance, the start-up costs to open a dining establishment include the rent (monthly fee) for space in a building, the kitchen equipment, the cost of food and ingredients, and many other fees. After these costs have been met, the restaurant owner is likely to want to offer customers alcoholic beverages. This requires two separate licenses, a wine-and-beer license and a liquor license. In the United States the fees for such documents vary from state to state. All of these impediments benefit existing restaurants by restricting the number of new competitors that can enter the market and lure away customers.

Barriers to entry can also refer to the obstacles an individual faces when seeking employment in a certain trade or occupation. These barriers frequently include educational and licensing requirements. For example, in the United States a person who wants to become a lawyer must graduate from law school and pass a bar examination (a test given by each state, which, if completed successfully, certifies that an individual can practice law in that state). In other fields, such as athletics and the arts, the degree of talent required to make a living is an effective barrier to entry.

When Did It Begin

Political rule by an aristocracy (a small, privileged social class that usually consists of nobility) was one of the earliest and most effective barriers to entry for individuals seeking to rise in society and acquire wealth. Throughout history most aristocracies have been hereditary, meaning that an individual had to be born into this group in order to claim membership. In Western culture the aristocratic or noble class came into being in ancient Greece, where leaders of armies were judged to be the most virtuous, and therefore the best, men in society. They were given authority to make decisions on behalf of the community, a privilege they earned through their deeds. Throughout the Middle Ages (approximately 500 to 1500), as nations were formed in Europe, membership in the aristocracy gradually came to be determined by birth. If an individual was not born into an aristocratic family, that person would not be able to gain entrance into the aristocratic class.

In the Early Middle Ages (from about 500 to 1000), guilds (associations of craftspeople such as blacksmiths or carpenters) began to appear, acting as a new kind of barrier to entry. These organizations were composed of people who were in a lower class than the aristocrats and provided goods and services for them. Guilds had formal systems in place for admitting, training, and ranking members. Individuals entered as apprentices (beginners learning the trade), developed into journeymen (who were trained but still supervised by an expert), and progressed to become master craftsmen. Advancing to this final status required the formal approval of all members of the guild.

More Detailed Information

In the arena of nationally distributed products and services, two of the most significant barriers to entry are economies of scale and brand recognition (also called brand awareness). The term economy of scale refers to the way that, when a business grows, its average production costs usually decrease. As a result, large businesses tend to be less expensive to operate than small businesses. For example, consider the challenges facing a small entrepreneur who wants to manufacture and distribute ice cream in the northeastern region of the United States but who must compete against a national brand-name ice cream company. Suppose the larger business spends $10,000 a day to produce ice cream, and the smaller one will only spend $5,000. The national company is spending twice as much money, but it produces 7,500 gallons of ice cream a day, while the regional company will only produce 2,500 gallons. According to these figures, the larger company spends $1.33 per gallon of ice cream. Meanwhile, the smaller company will spend $2.00 per gallon. Thus, the average cost of producing a gallon of ice cream is significantly lower for the larger company. This allows it to sell its ice cream for less money, making it difficult for the regional business to lure customers away from the national brand.

The other major barrier is brand recognition, which refers to customer familiarity with a product or a corporation. For example, Coca-Cola and Pepsi have created a high degree of brand awareness. Most American consumers immediately think of these two brands first when they consider purchasing a cola beverage. Any company that wanted to put a new cola on the market would have a difficult time getting prospective customers to think of its product before Coke and Pepsi.

Economists and lawmakers monitor barriers to entry because these market factors affect competition. If barriers to entry are too difficult to overcome, the number of manufacturers for a specific good decreases. This could lead to a situation in which there is only one provider of a good; in such a case the company producing that good is called a monopoly. For example, if Pepsi were the only manufacturer of soft drinks, the company would have a monopoly in this market and would be free to charge as much as it wished for its products. Except in rare cases, monopolies are illegal in the United States. On the other hand, if there are no barriers to entry to a given market, too many producers can enter that market, and the excessive competition will keep prices too low. This will reduce profits, which in turn will limit the amount of money companies can invest in improving their products.

Recent Trends

The technology boom and the rise of the Internet since 1995 have had a series of effects on the barriers to entry in the computer industry. When the Internet and home computers became popular in the mid-1990s, many new types of businesses arose. Three of these were Web-development firms (companies that design and maintain websites for other companies and for individuals), online stores (businesses that sell products over the Internet), and technical support (companies and individuals that help others maintain their computer systems). Early in this period people could open businesses in these fields with little trouble because customers were eager to acquire these products and services but had few standards for judging the quality of what they were receiving. The only things preventing an individual from creating one of these businesses were the start-up costs and the technical knowledge required to provide such services.

More significant barriers to entry in the computer industry have gradually emerged. For instance, with regard to Web development, websites have grown more sophisticated and require not only significant computer programming skills but also expertise in design. The majority of the initial online stores failed, and e-commerce soon became a big-business endeavor dominated by large operations such as eBay and Amazon.com. In the field of technical support, a major barrier to entry for individuals is that licensing policies have gotten stricter and more costly.