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‘Barriers to entry’ is an economics term that refers to factors that can discourage or prevent potential competition from entering into a market or sector. Thus these barriers to entry, natural or artificial, generally reduce competition, allowing incumbents to retain a larger market share than otherwise (especially in an oligopoly).
Many barriers to entry exist, and they can vary somewhat depending on the industry in question. But the most common barriers to entry across industries are, perhaps, ones required to set up a business. The first obstacle that probably comes to mind is money. Of course, many other hurdles stand in the way—for example, obtaining the proper licenses, permits or other regulatory clearances.
How and Why Barriers to Entry Hurt the Public
Barriers to entry can significantly work to the benefit of incumbent firms. Established businesses can maintain their significant market share and therefore maximize profits. In and of itself, this obviously isn’t bad. Businesses have no obligation whatsoever to help new competitors enter into their market—in many cases, that would be bad for business.
But what’s that got to do with you?
Market competition often breeds innovation and productivity, better products at cheaper costs for the public. Barriers to entry can prevent that healthy economic competition and growth from which we could all benefit. Yes, all companies will face barriers to entry. It’s just a reality of doing business. But there’s a serious problem if artificial barriers of entry add further insurmountable hurdles along a potential competitor’s path to success.
The ZTM community knows that many businesses, including some corporations, act ethically. We are trying to identify and expose crony capitalism and hold those involved accountable. That way, good people and businesses can properly thrive and enjoy the piece of the piece they’re all due.
The public has voted! See where citizens believe the economy has been rigged…
Types of Barriers to Entry
According to the Organization for Economic Co-operation and Development (the OECD), scholars have long debated the definition of the term with little resolution. To some, obstacles that every business in any given sector faces to enter into the market should not be considered barriers to entry. On the other hand, some adopt the view that anything blocking a business from entering into the market constitutes a barrier to entry.
While properly defining terms has its uses, our concern comes down to how we can identify and eliminate rigged barriers to entry that should not exist in an ethical economy.
With that in mind, three main types of barriers to entry exist:
Government Action & Legal Barriers
In some cases, a government controls its own monopoly or grants a single firm total control over a market. The barriers to entry (e.g. patents, copyright, etc.) in these government-granted or government-controlled monopolies are deliberately set up so there is no potential for competition. This can sound like a moral minefield, and it definitely has been at times.
In a government-granted monopoly, a government gives a private individual or a business the right to serve as the sole provider of a commodity or service. The government will establish regulatory and legal barriers to entry to prevent any competition.
A government-granted monopoly commonly occurs in the pharmaceutical industry, where companies protect their innovative treatments with patents.
Telecom giant AT&T actually functioned as an unintentional government-granted monopoly in the U.S., from 1913 until 1984. According to a study by Adam Thierer, a senior research fellow at the Cato Institute, the 19th century actually brought much competition in the telecom industry. Options expanded and prices dropped. AT&T, early in the 20th century, began a campaign advertised as “One Policy, One System, Universal Service.”
Thierer writes, “[AT&T president Theodore Newton Vail] decided to enter an agreement that would appease governmental concerns while providing AT&T a firm grasp on the industry. On December 19, 1913, the “Kingsbury Commitment” was reached…the agreement outlined a plan whereby AT&T would sell off its $30 million in Western Union stock, agree not to acquire any other independent companies, and allow other competitors to interconnect with the Bell System. The Kingsbury Commitment was thought to be pro-competitive. Yet, this was hardly an altruistic action on AT&T’s part. The agreement was not interpreted by regulators so as to restrict AT&T from acquiring any new telephone systems, but only to require that an equal number be sold to an independent buyer for each system AT&T purchased. Hence, the Kingsbury Commitment contained a built-in incentive for monopoly-swapping rather than continued competition.”
So, what was meant to promote competition ironically created a monopoly, according to Thierer.
After pushback in the 1970s, the government eventually reached a compromise mandating the breakup of AT&T in 1984. Phone service across the board, from pricing to quality, reportedly increased. Also, new telecom players emerged, one infamously started by the ‘Telecom Cowboy’ Bernard Ebbers that would ultimately end in what’s known as the Worldcom scandal.
Wehe, a team of researchers at Northeastern University, University of Massachusetts — Amherst and Stony Brook University, conducted a study on traffic shaping showing evidence that “nearly every US cellular ISP (CISP) throttles (i.e., sets a limit on available bandwidth)…for at least one streaming video provider.”
Is your internet service provider giving you the service you paid for? See what the ZT community has reported on the matter…
In a government-controlled monopoly, a government creates an agency to hold a monopoly over an industry. A government would want to create a monopoly if they feel it can provide a commodity, or commodities, at a fair price. If an industry requires a great deal of costs that make it cost-prohibitive for multiple competitors, then it might be best that the government provides those services.
For example, think about utility companies that supply your water, gas or electricity. You would have to pay much more if 10 rival electricity companies had to install their own electric lines to provide power to each of their customers. Utility companies would have to charge their customers much more just to break even.
Another example of a government monopoly is the United States Postal Service (USPS). On the surface, this might not make sense when there’s UPS, FedEx, DHL, etc. The USPS actually has a legal monopoly over your mailbox and mail of a certain size and dimension under U.S. code Title 39.
Natural (Structural) Barriers to Entry
Natural, or structural, barriers to entry refer to those hurdles that simply come with doing business in your industry. Many of these structural barriers are just hard realities young businesses have to face, and are likely not rigged against them.
Economies of scale
In an economy of scale, there’s a sweet spot where output is just high enough to achieve the lowest production costs. The intersection of P2 and Q2 in the graph below represents the ideal output to cost ratio. Companies with limited production (likely small or emerging ones) cannot achieve that level of output, so they will have to deal with high(er) average production costs. This reality can deter would be competitors from entering into a market.
From Economics Help
The network effect refers to the phenomenon where the value of a product/service increases in conjunction with increases in usership. If incumbents have established strong networks, it can limit the chances of potential competition to gain a proper foothold in the industry (as value is directly linked to number of users).
For example, e-commerce sites such as Amazon, Etsy, Ebay, etc. exemplify the network effect. The more sellers these sites can attract, a wider range of potential customers will be able to find what they want or need.
Put it this way. If you aren’t looking for a very niche product that you’d rather purchase from a specialty store, you can pretty much find anything you need on Amazon. It becomes a one-stop shop without the commute. An e-commerce startup would not be able to offer the range of products (along with other perks such as fast delivery times) simply because they do not have an extensive network of sellers.
High set-up, and R&D costs
Setting up a business involves many ‘sunk costs,’ spent money that cannot be recovered. Rent, advertising and marketing, payroll, the list goes on. Perhaps less expensive as businesses can use digital storefronts and market via social media, getting your business up and running can still cost a great deal. Time, too, if we aren’t speaking only in monetary terms. These costs can serve as barriers to entry, preventing potential competitors from entering the market.
Also, certain industries spend a good portion of their revenue on innovation and R&D. The usual culprits are the tech and pharmaceutical/medical fields, but there’s R&D costs even in fashion. The amount of spending required to completely develop, pass regulatory tests (FDA, for example), and eventually produce a product can prevent potential competitors from joining a market.
Have you wondered why U.S. drug prices are so much higher than in other countries? The RAND Corporation, a nonprofit, used 2018 data to conduct a study finding that prescription drug prices in the U.S. are 256% higher vs other countries. See whether the Zero Theft community has voted that the pharmaceutical industry is ripping off the U.S. public.
The supply of a resource or raw material naturally limits the amount of possible production. As expected, businesses that get in first can obtain as much of the scarce resource as they can. Monopolizing a scarce resource is a barrier to entry as new entrants cannot even begin to provide or produce a commodity because they do not have the necessary resources or materials.
Artificial (Strategic) Barriers to Entry
Artificial, or strategic, barriers to entry refer to obstacles set up by incumbent businesses to sometimes prevent new competition from entering into the market. These barriers to entry range from completely legitimate to unethical (sometimes even illegal).
We should note that our list is, by no means, comprehensive.
Predatory pricing refers to when a firm or colluding firms intentionally lower prices in order to force competitors out of the market. It’s a violation of antitrust law, and is therefore illegal.
According to The Washington Post, Walmart was charged with violating Arkansas state law “by selling goods below cost to drive competitors out of business” in 1993. Concerns over Walmart’s low-cost strategy has remained a talking point even in more recent years.
Incumbent companies can also acquire smaller rivals in order to reduce market competition and potentially gain the rights to an innovative product. If acquisitions become widespread in an industry, then power will get consolidated in a few major players. That can seriously harm competition, productivity, and innovation.
In February 2020, the Federal Trade Commission (FTC) announced its investigation into whether Big Tech has created an anti-competitive market through numerous mergers and acquisitions. According to academic research, over the last five years Amazon is reported to have made 42 acquisitions, Apple 33, Facebook 21, Google (Alphabet) 48 and Microsoft 53.
This barrier to entry refers to the costs involved when a customer changes service provider. For example, you might be used to using a certain program to edit videos. You have established your workflow and can complete your tasks efficiently. It would take a great deal to get you to switch, and that decision does not solely come down to monetary costs. The time you have to spend learning the program probably deters many from switching to a competitor.
An example of a financial switching cost would be when your phone service provider has you sign a contract to get a deal on a phone. The costs incurred by breaking the contract deters customers from jumping ship before it has expired.
Contracts, patents, and licenses
Contracts, patents, and licenses can make things difficult (or impossible) for new companies to enter into a market. For example, a new company can come in at a serious disadvantage when competing for government contracts against established partners. Those existing relationships can sometimes lead to cronyism, wherein contractors secure a deal because of personal connections rather than for the merits of their proposal.
Furthermore, in the pharmaceutical industry in particular, patent abuse remains a huge concern for the public and regulators alike. This barrier of entry prevents new entrants from providing cheap(er) generics of brand name drugs beyond the granted patent protection period. The Association for American Medicines (AAM) discusses the case of Humira, a rheumatoid arthritis drug that has generated close to $20 billion three years in a row (2018, 2019, and 2020). The AAM writes, “The initial patent on the product expired in 2016, but within the three years before expiration, the company applied for and obtained over 75 patents that would extend its monopoly to 2034 – and keep this enormously expensive treatment inaccessible to many patients. To break AbbVie’s perpetual monopoly, companies must engage in time-intensive, expensive patent litigation, thus allowing the drug company to continue to profit as a result of its tactics.”
How YOU can Break Down Barriers to Entry
“What corporations fear is the phenomenon now known, rather inelegantly, as ‘commoditization.’ What the term means is simply the conversion of the market for a given product into a commodity market, which is characterized by declining prices and profit margins, increasing competition, and lowered barriers to entry.”
James Surowiecki, in an article for Slate
Every business will face some barriers to entry, especially structural ones. That’s just the reality of the matter. But we cannot allow incumbent companies to set up artificial barriers to entry that stifle healthy, productive, and ethical competition that should be occurring.
The public suffers. From a lack of options, higher prices, potentially lower quality products. Crony capitalism, while a misnomer, must go.
And you can contribute.
On our voting platform, citizens author theft proposals, and the community decides whether that investigation has convincingly proven (1) theft is or isn’t occurring in a specific area of the economy, and (2) how much is being stolen or possibly saved. Through direct democracy, we can collectively decide where the problem areas are and start working on addressing them systematically.
The Zero Theft Movement does not have any interest in partisan politics/competition or attacking/defending one side. We seek to eradicate theft from the U.S economy. In other words, how the wealthy and powerful rig the system to steal money from us, the everyday citizen. We need to collectively fight against crony capitalism in order for us to all profit from an ethical economy.
Terms like ‘steal,’ ‘theft,’ and ‘crime’ will frequently appear throughout the article. Zero Theft will NOT adhere strictly to the legal definitions of these terms (since congress sells out). We have broadly and openly defined terms like ‘steal’ and ‘theft’ to refer to the rigged economy and other debated unethical acts that can cause citizens to lose out on money they deserve to keep.