Session 5
Session 5 – Mini-Lecture: Summary
Notes
SLIDE 1
Lecture Overview: This session focuses on the competitive analysis and strategy
surrounding the theory of entry and entry deterrence.
Core Objectives:
Identify and analyse the various types of entry barriers that can naturally exist within
an industry.
Examine the specific entry barriers that incumbent (existing) firms can actively raise
against new competitors.
Key Focus Area: Strategic Entry Barriers:
Special attention is given to strategic entry barriers.
These specific barriers rely heavily on game theory logic.
They are explicitly highlighted as being more complex and generally more difficult to
understand and grasp than other types of barriers.
SLIDE 2
1. The Threat of Potential Entrants
Strategic Consideration:
o Potential entrants represent a crucial element in the five forces model, and
incumbent firms must carefully consider how both existing rivals and potential
entrants will respond to their strategic decisions.
Reasons to Avoid Entry: Incumbents generally want to prevent new firms from
entering the market for several reasons:
o Entrants capture existing market share from the incumbents.
o An increase in the number of players heightens industry rivalry, which frequently
leads to more intense price competition.
o Entrants are often more heterogeneous than incumbents (differing in size,
experience, or business practices), which makes it significantly more difficult for
firms to coordinate on pricing.
Incumbent Action: Because of these threats, incumbent firms actively seek to take
actions that impede entry by raising entry barriers.
2. Classification of Entry Barriers
The lecture categorizes entry barriers into three distinct types, which is noted as a more
accurate classification than what is found in the textbook.
Type 1: Exogenous (Structural) Entry Barriers
o Definition: These are structural characteristics of an industry that incumbent
firms cannot directly affect or change.
o Examples: Common exogenous barriers include the minimum efficient scale
required to compete and government-imposed regulations.
Page 1 of 42
, Session 5
Type 2: Endogenous Entry Barriers
o Definition: These are barriers that firms can actively influence and change
through their strategic actions.
o Examples: Endogenous barriers involve elements such as technological
knowledge, patenting, advertising efforts, and securing access to resources or
distribution channels.
o Dual Benefit: A defining feature of endogenous barriers is that they often serve
a dual purpose: they can discourage entry while simultaneously providing a
direct positive effect for the firm, such as enhanced profits or an improved
competitive position.
Type 3: Strategic Entry Barriers
o Definition: These are barriers raised specifically and exclusively to reduce the
threat of entry.
o Key Characteristics: Unlike endogenous barriers, strategic entry barriers have
absolutely no direct positive effect on the firm’s regular operations or
profitability.
o Cost and Risk: Because they exist purely for entry threat reduction and lack
secondary business benefits, they tend to be very costly => firms must be
extremely careful when choosing to employ them.
SLIDE 3
Exogenous (or structural) entry barriers are industry-specific factors that incumbent firms
cannot directly change. The lecture details three primary exogenous barriers, followed by a
brief introduction to a more endogenous barrier:
1. Minimum Efficient Scale (MES) Relative to Market Size
When the minimum efficient scale required to compete is large compared to the overall size
of the market, potential entrants are trapped between two highly unprofitable choices:
Strategy A: Enter at Minimum Efficient Scale (Large Scale).
The entrant sets up large-scale production to achieve efficiency and low costs.
The Result: The massive influx of new output floods the market, inevitably triggering a
price war. Prices drop so low (potentially close to marginal cost levels) that the entrant
cannot make a profit.
Strategy B: Enter at a Small Scale.
The entrant starts small to avoid provoking an aggressive price reaction from incumbents.
The Result: Producing at a small scale is inefficient, leaving the entrant with a severe
cost disadvantage compared to incumbents, guaranteeing they lose out.
The Risk of Sunk Costs:
Knowing they will lose out either way, entrants are often discouraged from entering.
This is compounded by the fact that entry requires setting up physical plants and
buying machinery.
These investments are largely sunk costs, meaning if the firm fails, the money cannot
be recouped, making entry incredibly risky.
2. The Experience Curve and Dynamic Economies of Scale
The Incumbent Advantage:
Incumbent firms have been active in the industry longer, meaning they have a significantly
larger cumulative production and deeper experience.
Page 2 of 42
, Session 5
Cost Reduction:
Through dynamic economies of scale (learning curve effects), firms are able to
systematically reduce their costs as their cumulative production and experience increase over
time.
Barrier to Entry:
This creates a powerful cost advantage for the incumbent that is extremely difficult for a new
entrant to mimic, because the entrant has exactly zero cumulative experience in that
industry.
Example: The semiconductor industry is a prime example of a market with strong experience
curves.
3. Government Protection and Regulation
Government actions and legal structures can structurally limit who is allowed to compete in
an industry.
Licensing and Quotas:
Many industries require specific government licenses to operate, such as utilities,
telecoms, or broadcasting. In broadcasting, for instance, entry is naturally capped
because there are only a limited number of frequencies available.
Zoning and Planning Laws:
Government regulations can dictate where businesses are allowed to operate, creating
artificial scarcity. For example, planning laws restrict exactly where petrol stations can
be built, preventing entrants from securing prime locations.
4. Transition to Endogenous Barriers (Network Externalities)
After covering structural barriers, the lecture begins transitioning to barriers that are more
endogenous (meaning firms can influence them).
The primary example introduced here is network externalities, which are an important
driver of sustainable competitive advantage. (Note: The professor mentions this concept will
be explored in much greater depth in Session 8).
SLIDE 4: Endogenous Entry Barriers (Part 1)
This section transitions into endogenous entry barriers - factors that incumbent firms can
consciously influence and strategize around to disadvantage entrants.
1. Network Externalities
Although not applied to the specific case in Session 5, network externalities are a crucial
concept for completeness regarding entry barriers.
Definition:
Network externalities are demand-side externalities where the value of a service or
product increases for a new consumer as more existing consumers use it.
The Power of the Installed Base:
Incumbents typically possess a large “installed base” of existing customers. This large
base inherently increases the product’s value, attracting even more customers and
creating a powerful, self-sustained growth cycle.
The Entrant’s Disadvantage:
New entrants start with no installed base, putting them at a severe disadvantage because
their product inherently offers less value to the consumer on day one.
Page 3 of 42
, Session 5
Types of Networks:
Physical Networks: For example, the traditional fixed-line telephone network. It offers little
value if only two people are connected, but immense value if the whole world is
connected.
Non-Physical Networks: Digital services like WhatsApp function on the exact same logic;
the more users there are, the more free communication can occur.
Strategic (Endogenous) Manipulation:
Firms actively manage these externalities. They often try to keep their networks exclusive
by disallowing connectivity to rival networks, or by charging extremely high connectivity
fees (e.g., early fixed-line operators charging mobile networks high fees to protect their
profitable domain).
2. Access to Key Inputs
Securing preferential access to the critical elements required to compete in an industry is
another powerful endogenous entry barrier. Because firms actively strategize to maintain this
access, it is considered an endogenous factor.
Types of Key Inputs:
Important Customers: Securing buyers through long-term contracts.
Distribution Systems: Locking down distribution channels, which is highly critical in
industries like car sales.
Raw Materials: Monopolizing resources, such as the classic example of De Beers
owning a vast majority of diamond mines, making it nearly impossible for a new rival to
source diamonds.
Unique Locations: Securing prime geographical locations, a strategy famously
employed by Walmart (covered in Session 7).
The Strategic Effect:
By consciously locking down these inputs, incumbents create artificial scarcity,
ensuring that potential entrants cannot compete on a level playing field.
SLIDE 5: Endogenous Entry Barriers (Part 2) & Introduction to
Strategic Entry Barriers
1. Brand Loyalty and Reputation (Endogenous Barrier)
Classification Note: While the textbook classifies brand loyalty as a structural (exogenous)
barrier, the professor explicitly categorizes it as an endogenous barrier because firms actively
invest to create it.
The Investment Barrier:
Building a strong brand through advertising is both highly time-consuming and
expensive. Furthermore, these investments are usually sunk costs that are specific to
the industry.
Incumbent Advantage:
Because incumbents have already established their brands and secured loyal
customers, new entrants face a massive hurdle
=> they must invest heavily in a long process just to try and steal those customers
away.
Crucial for “Experience Goods”:
Brand reputation acts as a particularly strong barrier in markets for durable goods or
experience goods.
Page 4 of 42
Session 5 – Mini-Lecture: Summary
Notes
SLIDE 1
Lecture Overview: This session focuses on the competitive analysis and strategy
surrounding the theory of entry and entry deterrence.
Core Objectives:
Identify and analyse the various types of entry barriers that can naturally exist within
an industry.
Examine the specific entry barriers that incumbent (existing) firms can actively raise
against new competitors.
Key Focus Area: Strategic Entry Barriers:
Special attention is given to strategic entry barriers.
These specific barriers rely heavily on game theory logic.
They are explicitly highlighted as being more complex and generally more difficult to
understand and grasp than other types of barriers.
SLIDE 2
1. The Threat of Potential Entrants
Strategic Consideration:
o Potential entrants represent a crucial element in the five forces model, and
incumbent firms must carefully consider how both existing rivals and potential
entrants will respond to their strategic decisions.
Reasons to Avoid Entry: Incumbents generally want to prevent new firms from
entering the market for several reasons:
o Entrants capture existing market share from the incumbents.
o An increase in the number of players heightens industry rivalry, which frequently
leads to more intense price competition.
o Entrants are often more heterogeneous than incumbents (differing in size,
experience, or business practices), which makes it significantly more difficult for
firms to coordinate on pricing.
Incumbent Action: Because of these threats, incumbent firms actively seek to take
actions that impede entry by raising entry barriers.
2. Classification of Entry Barriers
The lecture categorizes entry barriers into three distinct types, which is noted as a more
accurate classification than what is found in the textbook.
Type 1: Exogenous (Structural) Entry Barriers
o Definition: These are structural characteristics of an industry that incumbent
firms cannot directly affect or change.
o Examples: Common exogenous barriers include the minimum efficient scale
required to compete and government-imposed regulations.
Page 1 of 42
, Session 5
Type 2: Endogenous Entry Barriers
o Definition: These are barriers that firms can actively influence and change
through their strategic actions.
o Examples: Endogenous barriers involve elements such as technological
knowledge, patenting, advertising efforts, and securing access to resources or
distribution channels.
o Dual Benefit: A defining feature of endogenous barriers is that they often serve
a dual purpose: they can discourage entry while simultaneously providing a
direct positive effect for the firm, such as enhanced profits or an improved
competitive position.
Type 3: Strategic Entry Barriers
o Definition: These are barriers raised specifically and exclusively to reduce the
threat of entry.
o Key Characteristics: Unlike endogenous barriers, strategic entry barriers have
absolutely no direct positive effect on the firm’s regular operations or
profitability.
o Cost and Risk: Because they exist purely for entry threat reduction and lack
secondary business benefits, they tend to be very costly => firms must be
extremely careful when choosing to employ them.
SLIDE 3
Exogenous (or structural) entry barriers are industry-specific factors that incumbent firms
cannot directly change. The lecture details three primary exogenous barriers, followed by a
brief introduction to a more endogenous barrier:
1. Minimum Efficient Scale (MES) Relative to Market Size
When the minimum efficient scale required to compete is large compared to the overall size
of the market, potential entrants are trapped between two highly unprofitable choices:
Strategy A: Enter at Minimum Efficient Scale (Large Scale).
The entrant sets up large-scale production to achieve efficiency and low costs.
The Result: The massive influx of new output floods the market, inevitably triggering a
price war. Prices drop so low (potentially close to marginal cost levels) that the entrant
cannot make a profit.
Strategy B: Enter at a Small Scale.
The entrant starts small to avoid provoking an aggressive price reaction from incumbents.
The Result: Producing at a small scale is inefficient, leaving the entrant with a severe
cost disadvantage compared to incumbents, guaranteeing they lose out.
The Risk of Sunk Costs:
Knowing they will lose out either way, entrants are often discouraged from entering.
This is compounded by the fact that entry requires setting up physical plants and
buying machinery.
These investments are largely sunk costs, meaning if the firm fails, the money cannot
be recouped, making entry incredibly risky.
2. The Experience Curve and Dynamic Economies of Scale
The Incumbent Advantage:
Incumbent firms have been active in the industry longer, meaning they have a significantly
larger cumulative production and deeper experience.
Page 2 of 42
, Session 5
Cost Reduction:
Through dynamic economies of scale (learning curve effects), firms are able to
systematically reduce their costs as their cumulative production and experience increase over
time.
Barrier to Entry:
This creates a powerful cost advantage for the incumbent that is extremely difficult for a new
entrant to mimic, because the entrant has exactly zero cumulative experience in that
industry.
Example: The semiconductor industry is a prime example of a market with strong experience
curves.
3. Government Protection and Regulation
Government actions and legal structures can structurally limit who is allowed to compete in
an industry.
Licensing and Quotas:
Many industries require specific government licenses to operate, such as utilities,
telecoms, or broadcasting. In broadcasting, for instance, entry is naturally capped
because there are only a limited number of frequencies available.
Zoning and Planning Laws:
Government regulations can dictate where businesses are allowed to operate, creating
artificial scarcity. For example, planning laws restrict exactly where petrol stations can
be built, preventing entrants from securing prime locations.
4. Transition to Endogenous Barriers (Network Externalities)
After covering structural barriers, the lecture begins transitioning to barriers that are more
endogenous (meaning firms can influence them).
The primary example introduced here is network externalities, which are an important
driver of sustainable competitive advantage. (Note: The professor mentions this concept will
be explored in much greater depth in Session 8).
SLIDE 4: Endogenous Entry Barriers (Part 1)
This section transitions into endogenous entry barriers - factors that incumbent firms can
consciously influence and strategize around to disadvantage entrants.
1. Network Externalities
Although not applied to the specific case in Session 5, network externalities are a crucial
concept for completeness regarding entry barriers.
Definition:
Network externalities are demand-side externalities where the value of a service or
product increases for a new consumer as more existing consumers use it.
The Power of the Installed Base:
Incumbents typically possess a large “installed base” of existing customers. This large
base inherently increases the product’s value, attracting even more customers and
creating a powerful, self-sustained growth cycle.
The Entrant’s Disadvantage:
New entrants start with no installed base, putting them at a severe disadvantage because
their product inherently offers less value to the consumer on day one.
Page 3 of 42
, Session 5
Types of Networks:
Physical Networks: For example, the traditional fixed-line telephone network. It offers little
value if only two people are connected, but immense value if the whole world is
connected.
Non-Physical Networks: Digital services like WhatsApp function on the exact same logic;
the more users there are, the more free communication can occur.
Strategic (Endogenous) Manipulation:
Firms actively manage these externalities. They often try to keep their networks exclusive
by disallowing connectivity to rival networks, or by charging extremely high connectivity
fees (e.g., early fixed-line operators charging mobile networks high fees to protect their
profitable domain).
2. Access to Key Inputs
Securing preferential access to the critical elements required to compete in an industry is
another powerful endogenous entry barrier. Because firms actively strategize to maintain this
access, it is considered an endogenous factor.
Types of Key Inputs:
Important Customers: Securing buyers through long-term contracts.
Distribution Systems: Locking down distribution channels, which is highly critical in
industries like car sales.
Raw Materials: Monopolizing resources, such as the classic example of De Beers
owning a vast majority of diamond mines, making it nearly impossible for a new rival to
source diamonds.
Unique Locations: Securing prime geographical locations, a strategy famously
employed by Walmart (covered in Session 7).
The Strategic Effect:
By consciously locking down these inputs, incumbents create artificial scarcity,
ensuring that potential entrants cannot compete on a level playing field.
SLIDE 5: Endogenous Entry Barriers (Part 2) & Introduction to
Strategic Entry Barriers
1. Brand Loyalty and Reputation (Endogenous Barrier)
Classification Note: While the textbook classifies brand loyalty as a structural (exogenous)
barrier, the professor explicitly categorizes it as an endogenous barrier because firms actively
invest to create it.
The Investment Barrier:
Building a strong brand through advertising is both highly time-consuming and
expensive. Furthermore, these investments are usually sunk costs that are specific to
the industry.
Incumbent Advantage:
Because incumbents have already established their brands and secured loyal
customers, new entrants face a massive hurdle
=> they must invest heavily in a long process just to try and steal those customers
away.
Crucial for “Experience Goods”:
Brand reputation acts as a particularly strong barrier in markets for durable goods or
experience goods.
Page 4 of 42
