1. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Threat of Entry: Factors that Reduce Market Share Potential for New Entrants MANEC 387 Economics of Strategy MANEC 387 Economics of Strategy David J. Bryce

2. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 The Structure of Industries Competitive Rivalry Threat of new Entrants Bargaining Power of Customers Threat of Substitutes Bargaining Power of Suppliers From M. Porter, 1979, “How Competitive Forces Shape Strategy”

3. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Barriers to Entry A barrier to entry is any factor that –Increases the costs born by potential entrants (relative to incumbents), after they enter the market –Decreases the market share potential of entrants upon entering the industry –Other factors Trade restrictions (tariffs, quotas, voluntary export restraints, infant industry protection, embargoes) Government regulation of industries Industry certification boards (CPAs, Actuaries) A barrier to entry is any factor that –Increases the costs born by potential entrants (relative to incumbents), after they enter the market –Decreases the market share potential of entrants upon entering the industry –Other factors Trade restrictions (tariffs, quotas, voluntary export restraints, infant industry protection, embargoes) Government regulation of industries Industry certification boards (CPAs, Actuaries)

4. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Barriers Limiting Market Share Product differentiation Advertising/Brand image Access to distribution Customer switching costs – exploiting network externalities Expected retaliation Product differentiation Advertising/Brand image Access to distribution Customer switching costs – exploiting network externalities Expected retaliation

5. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Branding A primary means of erecting a differentiation barrier is to build “brand equity”A primary means of erecting a differentiation barrier is to build “brand equity” –Brand equity is represented by cumulative investments in raising awareness and/or improving the image of a brand usually through advertising A primary means of erecting a differentiation barrier is to build “brand equity”A primary means of erecting a differentiation barrier is to build “brand equity” –Brand equity is represented by cumulative investments in raising awareness and/or improving the image of a brand usually through advertising

6. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Examples Brand as Barrier:Brand as Barrier: –Intel Inside campaign Rapid Brand Building for a New Entrant:Rapid Brand Building for a New Entrant: –AstraZeneca’s “Purple Pill” campaign –AZ (re)entered the market for heartburn therapy with a major effort to build brand equity Brand as Barrier:Brand as Barrier: –Intel Inside campaign Rapid Brand Building for a New Entrant:Rapid Brand Building for a New Entrant: –AstraZeneca’s “Purple Pill” campaign –AZ (re)entered the market for heartburn therapy with a major effort to build brand equity

7. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002

8. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Access to Distribution Examples:Examples: –Coke and Pepsi access to bottlers and distribution to outlets (economies of scale in bottling) –Ready-to-eat cereal in getting and allocating scarce shelf space. –Energizer just entered the razor market. Why? Examples:Examples: –Coke and Pepsi access to bottlers and distribution to outlets (economies of scale in bottling) –Ready-to-eat cereal in getting and allocating scarce shelf space. –Energizer just entered the razor market. Why?

9. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Networks and Network Externalities Network – a collection of nodes connected by links Externality – the benefits/costs of a decision are not internalized by the decision-maker –Negative externalities impose costs on others –Positive externalities spread benefits on others Network externality – positive externality where the decision to join a network gives benefit to the existing members of the network. Value to customer depends on the number of other customers. Network – a collection of nodes connected by links Externality – the benefits/costs of a decision are not internalized by the decision-maker –Negative externalities impose costs on others –Positive externalities spread benefits on others Network externality – positive externality where the decision to join a network gives benefit to the existing members of the network. Value to customer depends on the number of other customers.

10. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Economics of Demand in a Network The nature of demand and dynamic adjustments to reach equilibrium differ under a network externality. Price Demand Supply Q Q Q Q Dynamic Adjustment Traditional Demand Network Externality

11. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Typology of Network Externalities Direct effects –Telephone networks and fax –QWERTY –Internet and E-Bay Indirect effects – complementary networks and “increasing returns” –Availability of software and service –Platforms and standards Direct effects –Telephone networks and fax –QWERTY –Internet and E-Bay Indirect effects – complementary networks and “increasing returns” –Availability of software and service –Platforms and standards

12. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Pricing – IBM vs. Apple Licensing – VHS vs. Betamax Alliances – Sony, Philips, and the Compact Disk Pre-emption – Osborne, Japan and HDTV Other examples – Netscape vs. Explorer – DIVX vs. DVD Pricing – IBM vs. Apple Licensing – VHS vs. Betamax Alliances – Sony, Philips, and the Compact Disk Pre-emption – Osborne, Japan and HDTV Other examples – Netscape vs. Explorer – DIVX vs. DVD Strategies for Network Externalities How do you become the standard?

13. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Strategic Implications of Network Externalities A product with increasing returns is so difficult to displace that its competitive advantage may be insurmountable. –Lock-in through increased switching costs –First-mover advantages imply that even a brief head start may be critical (time matters) –Inferior technologies may persist (history matters) To replace a standard, the value of a new product must exceed the combined value of the entrenched product and its network. A product with increasing returns is so difficult to displace that its competitive advantage may be insurmountable. –Lock-in through increased switching costs –First-mover advantages imply that even a brief head start may be critical (time matters) –Inferior technologies may persist (history matters) To replace a standard, the value of a new product must exceed the combined value of the entrenched product and its network.

14. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Overcoming Barriers to Entry Existing firms in other industries can leverage their capabilities as a platform for entry (economies of scale, knowledge, funds, brands, distribution channels) Technological change/Disruptive technologies Second mover advantages Changing legal/regulatory environment Acquire incumbent firms Existing firms in other industries can leverage their capabilities as a platform for entry (economies of scale, knowledge, funds, brands, distribution channels) Technological change/Disruptive technologies Second mover advantages Changing legal/regulatory environment Acquire incumbent firms Costs of entry must be less than the profits of entry Costs of entry must be less than the profits of entry

15. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 The Logic of Exit Short-run: firm produces as long as it covers marginal cost (MR>MC). Long-run: firm ceases production and exits if it does not expect to cover fixed costs (MR<ATC). Exit reduces supply, price rises, firm profits rise to zero. Short-run: firm produces as long as it covers marginal cost (MR>MC). Long-run: firm ceases production and exits if it does not expect to cover fixed costs (MR<ATC). Exit reduces supply, price rises, firm profits rise to zero.

16. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 The Problem of Barriers to Exit Barriers to exit exist when the costs of exit are greater than the losses of continued production. –Book value of assets greater than market value –Emotional ties to continued operation –Uncertain demand and high startup costs (real options) –Government support of “strategic industries” These barriers perpetuate oversupply and heighten price competition. Worse conditions than perfect competition Barriers to exit exist when the costs of exit are greater than the losses of continued production. –Book value of assets greater than market value –Emotional ties to continued operation –Uncertain demand and high startup costs (real options) –Government support of “strategic industries” These barriers perpetuate oversupply and heighten price competition. Worse conditions than perfect competition

17. David J. Bryce © 1996-2002 Some portions adapted from Baye © 2002 Barriers to Entry and Sustainability of Economic Profits Without barriers to entry, economic profits will attract entry that competes profits away. Effective barriers need only make the cost of entry greater than the potential profits or impose restrictions that limit market share and thus business viability Incumbents are concerned with whether barriers are high enough to protect current market structure. Potential entrants are concerned with how they can overcome entry barriers and still have other potential entrants deterred. Without barriers to entry, economic profits will attract entry that competes profits away. Effective barriers need only make the cost of entry greater than the potential profits or impose restrictions that limit market share and thus business viability Incumbents are concerned with whether barriers are high enough to protect current market structure. Potential entrants are concerned with how they can overcome entry barriers and still have other potential entrants deterred.