Entry and exit By A.V. Vedpuriswar

Entry & Exit Entry is pervasive in many industries and may take many forms. An entrant may be: a newly incorporated firm a firm diversifying its product line an existing firm but without a previous presence in the market an existing firm which is geographically diversifying A profit maximising firm will enter a market if the sunk costs of entry are less than the net present value of expected post entry profits. Post entry profits will depend on demand and cost conditions as well as the nature of post entry competition. Exit is the withdrawal of a product from a market by a firm that shuts down completely a firm that continues to operate in other markets

Barriers to Entry Barriers to entry allow incumbent firms to earn positive economic profits while making it unprofitable for newcomers to enter the industry. Barriers to entry may structural or strategic. Structural entry barriers result when the incumbent has natural cost or marketing advantages or benefits from favourable regulations. Strategic entry barriers result when the incumbent aggressively deters entry.

Structural entry barriers There are three main types of structural entry barriers: Control of essential resources Economies of scale and scope Marketing advantages of incumbency An incumbent is protected from entry if it controls a resource necessary for production. Of course, such an advantage is usually difficult to protect forever. When economies of scale are significant, established firms operating at or beyond the minimum efficient scale will have a substantial cost advantage over smaller entrants. An incumbent can exploit the umbrella effect to offset uncertainty about the quality of a new product that it is introducing. The brand umbrella makes the incumbent’s sunk cost of introducing a new product less than that of a new entrant. The umbrella effect may also increase the bargaining power of the incumbent vis-a-vis distributors and retailers.

Strategic Entry barriers Blockaded entry: Entry is blockaded if structural barriers are so high that the incumbent need not do anything to deter entry. Accommodated entry: Entry is accommodated if structural entry barriers are low and either entry deterring strategies will be ineffective or the cost to the incumbent of trying to deter entry exceeds the benefits it would gain from keeping the entrant out. Accommodated entry is typical in markets with growing demand or rapid technological improvements. Entry is so attractive that the incumbent(s) should not waste resources trying to prevent it. Deterred entry: Entry is deterred if the incumbent can keep the entrant out by employing an entry deterring strategy and in the process boost the incumbent’s profits.

Entry deterring strategies are worthwhile only if two conditions are met: The incumbent earns higher profits as a monopolist than it does as a duopolist. The strategy changes the entrants’ expectations about the nature of post entry competition.

Pricing Limit pricing refers to the practice by which an incumbent firm discourages entry by charging a low price before entry occurs. Predatory pricing refers to the practice of setting a low price in order to drive other firms out of business. The predatory firm expects that whatever losses it incurs while driving competitors from the market can be made up later through the exercise of market power. A predatory firm focuses on firms that have already entered the market. There are some conditions under which predatory pricing may be profitable. Entering firms must be uncertain about some characteristic of the incumbent firm on the level of market demand. The incumbent wants the entrant to believe that post entry prices will be low. If the entrant is certain about what determines post entry pricing, the entrant can analyse all possible post entry pricing scenarios and correctly forecast the post entry price. If the incumbent is best off selecting a high post entry price, the entrant will know this and will not be deterred from entering.

Holding excess capacity Excess capacity in an industry can serve as a useful entry barrier. By holding excess capacity, an incumbent may affect how potential entrants view post entry competition and thereby blockade entry. An incumbent firm can successfully deter entry by holding excess capacity under the following conditions: The incumbent has a sustainable cost advantage. This gives it an advantage in the event of entry and a subsequent price war. Market growth is slow. Otherwise demand will quickly strip capacity. The investment in excess capacity must be sunk prior to entry. Otherwise, the entrant might force the incumbent to back off in the event of a price war. The potential entrant should not itself be attempting to establish a reputation for toughness.

Summing up Aggressive price reductions to move down the learning curve, intensive advertising to create brand loyalty and acquiring patents for all variants of a product create high entry costs. Enhancing the firm’s reputation or predation through announcements, limit pricing and holding excess capacity change the entrant’s expectations of post entry competition.

Judo strategy Sometimes, smaller firms and potential entrants can use the incumbent’s size to their own advantage. This is known as judo economics. If an entrant can convince the incumbent that it does not pose a significant long term threat to the incumbent’s profitability, the incumbent might think twice about incurring large losses to drive the entrant from the market. Recall the Netscape Microsoft war.

Exit barriers To exit a market, a firm stops production and either redeploys or sells off its assets. For a firm, exit makes sense if the value of its assets in their best alternative use exceeds the present value from remaining in the market. Exit barriers commonly arise when firms have obligations that they must meet whether or not they case operations. Relationship specific productive assets have low resale value and are hence a second exit barrier. Government restrictions can also be an exit barrier.