Market Structures and Barriers to Entry

Barriers to Entry and Exit

• Barriers to entry block potential new entrants from profitably entering a market.
• Barriers to exit obstruct firms from leaving an industry, creating challenges for businesses that wish to withdraw.

Contestable Markets

• Contestable markets feature low barriers to entry and exit, where the cost structure for new firms equals that of incumbent firms.
• Perfectly contestable markets do not exist in reality; real-world markets vary in degrees of contestability.

Sunk Costs

• Sunk costs are non-recoverable expenses if a business exits an industry, discouraging firms from leaving.
• Examples include industry-specific capital inputs and non-transferable marketing expenditures.

Examples of Barriers to Entry

• Patents: Provide exclusive rights to inventors, limiting competition.
• Limit-pricing: Established firms may lower prices to levels that push new entrants into losses.
• Cost advantages: Incumbent firms benefit from operational experience, allowing for lower pricing and competitive flexibility.
• Advertising and marketing: Strong brand loyalty makes market entry costly for newcomers, especially in industries like cosmetics and automotive.
• R&D Expenditure: High investment in research and development can deter new entrants due to competitive advantages gained by existing firms.
• Presence of Sunk Costs: High initial costs and the risk of unrecoverable investments reduce the attractiveness of market entry.
• International Trade Restrictions: Tariffs and quotas can protect domestic industries, creating barriers for foreign competitors.
• Economies of Scale: Larger firms lower production costs, making it challenging for smaller entrants to compete effectively.

Examples of Barriers to Exit

• Asset-write-offs: Costs related to the disposal of fixed assets, stocks, and brand goodwill can discourage exit.
• Closure Costs: Includes redundancy payments and penalties linked to terminating leases and contracts.
• Loss of Business Reputation: Exiting can harm future consumer goodwill and reputation in the industry.
• Market Downturn Perception: Temporary downturns may tempt firms to stay in the market, hoping for recovery rather than losing investments.
• Sunk Costs: Non-recoverable costs act as a deterrent against leaving the market, entrenching firms in less favorable conditions.

Goodwill

• Goodwill refers to a business's established reputation, seen as a quantifiable asset when evaluating its sale price.

Hit-and-Run Entry

• Describes a strategy where firms temporarily enter a contestable market to capture short-term profits before rapidly exiting.