Basics of Market Entry and Exit

Basics of Market Entry and Exit Learning Objectives: Gain awareness of important findings of studies of entry and exit Understand the potential for both structural and strategic barriers to entry Understand the strategy implications of entry barriers in an industry

Forms of Entry • Entry could take place in different forms • An entrant may be a brand new firm (Example: Dreamworks SKG) • An entrant may also be an established firm that is diversifying into a new product/market (Example: Microsoft entering gaming systems market) • The form of entry is important when we analyze entry costs and strategic response to entry by the incumbents

Forms of Exit • Exit could also take different forms • A firm may simply fold up (Example: PanAm) • A firm may discontinue a particular product or product group or leave a particular market (Peugeot leaves the U.S. market)

Some Facts About Entry and Exit • Entry and Exit are pervasive – 30% to 40% of all firms in an industry will have entered / exited in a five-year span • Half of new entrants are diversifying firms • Entrants and exiters tend to be smaller than incumbent firms • Most entrants do not survive 10 years • Entry and exit rates vary by industry • Unlike new entrants, diversifying firms built plants on the same scale as incumbents Are these facts reflected in your industries? Why should we be concerned with entry and exit behavior?

Strategy Implications of Entry Barriers • Given the pervasiveness of entry, manages must monitor and account for new competitors • Few ‘diversifying’ competitors will build new plants • Managers can expect most new ventures to fail • Managers should be aware of entry and exit conditions within their industry

Barriers to Entry • Barriers to entry are factors that allow the incumbents to earn economic profit while it is unprofitable for the new firms to enter the industry • Barriers to entry can be classified into • Structural barriers to entry and • Strategic barriers to entry

Barriers to Exit • Barriers to exit are factors that make the firm continue producing under such conditions which would not have encouraged the firm to enter • Examples of such barriers are specialized assets labor agreements, commitment to suppliers and governmental regulations

Typology of Entry Conditions • Markets can be characterized by whether the existing barriers to entry are structural or strategic • Three entry conditions according to Joe Bain are • Blockaded entry • Accommodated entry • Deterred entry Blockaded …………… Deterred ………….. Accommodated

Blockaded Entry • Entry is considered to be blockaded when the incumbent does not need to take any action to deter entry • Existing structural barriers are effective in deterring entry

Accommodated Entry • With accommodated entry, incumbents do not bother to deter entry • This condition is typical of markets with growing demand or rapid technological change • Structural barriers may be low and strategic barriers may be ineffective in deterring entry or simply not cost effective

Deterred Entry • Entry is not blockaded (no structural barriers) • Entry deterring strategies are effective in discouraging potential rivals and are cost effective • Deterred entry is the only condition under which the incumbents should engage in predatory acts

Types of Structural Barriers The three main types of structural barriers to entry are • Control of essential resources by the incumbent • Economies of scale and scope • Marketing advantage of incumbency

Control of Essential Resources • Nature may limit the sources of certain inputs and the incumbents may be in control of these limited sources • Patents can prevent rivals from imitating a firms products • Special know how that is hard for the rivals to replicate may be zealously guarded by the incumbents Examples from your industries?

Economies of Scale and Scope • If economies of scale are significant, incumbent may face a high threshold of market share to be profitable • If entrant succeeds, intense price competition may ensue • Economies of scope in production may exists when multiple products that share inputs and production technology are produced in the same plant • Economies of scope in marketing are due to the bulky up front expenditure an entrant has to incur to achieve comparable brand awareness as the incumbent’s brand Examples from your industries?

Marketing Advantage of Incumbency • Incumbent can exploit the brand umbrella (different products sold under the same brand name) to introduce new products more easily than new entrants can • The brand umbrella can make it easy for the incumbent to negotiate the vertical channel (Example: It is easier to get shelf space with an established brand) Examples from your industries?

Entry Deterring Strategies • Some examples of entry deterring strategies are limit pricing, predatory pricing and capacity expansion • For these strategies to work • Incumbent must earn higher profits as a monopolist than as a duopolist and • The strategy should change the entrants’ expectations regarding post-entry competition Examples from your industries?

Limit Pricing • An incumbent using the limit pricing strategy will set the price sufficiently low to discourage entrants • The entrant observes the low price and concludes that the post entry price will be low as well and decides not to enter

Is Limit Pricing Rational? • When multiple periods are considered, the incumbent has to set the price low in each period to deter entry in the next period • Thus, the incumbent never gets to raise the price and does not reap the benefits of entry deterrence

Situations When Limit Pricing Works • Limit pricing will work if the incumbent has a cost advantage over the entrant • Limit pricing will work if the entering firm in uncertain regarding the market demand or some determinant of post-entry pricing such as incumbent’s marginal cost

Predatory Pricing • A firm using the predatory pricing strategy sets the price below short run marginal cost with the expectation of recouping the losses when the rival exits • Limit pricing is directed at potential entrants while predatory pricing is directed at entrants who have already entered

Is Predatory Pricing Rational? • If all the entrants can perfectly foresee the future course of incumbent’s pricing, predatory pricing will not deter entry • In experimental settings with complete information, predation did not occur • Chain store paradox: Many firms commonly perceived to engage in predatory pricing

Situations When Predatory Pricing Will Work • With uncertainty, predatory pricing can deter entry • To deter entry, incumbent has to establish a reputation for toughness • An incumbent can be ‘tough’ either due to low costs or due to an irrational desire for market share

Excess Capacity and Entry Deterrence • By holding excess capacity, the incumbent can credibly threaten to lower the price if entry occurs • Since an incumbent with excess capacity can expand output at a low cost, entry deterrence will occur even when the entrant is completely informed about the incumbent’s intentions • Note: excess capacity is not always strategic; temporary downturn in demand, “lumpy” additions

Situations When Excess CapacityWorks to Deter Entry • Incumbent has a sustainable cost advantage • Market demand growth is slow • Incumbent cannot back-off from the investment in excess capacity • Entrant is not the type trying to establish a reputation for toughness

Evidence on the Use of Entry Deterring Strategies • Price reductions to move down the learning curve • Intensive advertising to create brand loyalty • Enhancing reputation for predation using announcements and other means • Limit pricing • Holding excess capacity

Summary of Barriers to Entry Bain’s Typology of Entry Conditions: Blockaded …………… Deterred ………….. Accommodated Structural Entry Barriers • Control of essential resources • Economies of scale and scope • Marketing advantages of incumbency Strategic Entry Barriers • Limit pricing (low price prior to entry) • Predatory pricing (low price post entry) • Capacity expansion (build / hold excess capacity) Examples of entry barriers with your firms / industries?

Basics of Market Entry and Exit