Impact Of Barriers To Entry On Market Strategy

Purpose – The purpose of this paper is to review previous research and to propose a model for the impact of barriers to entry on the market strategy of an entrant firm, where product/market scope and product differentiation are central strategy components. The paper asks, what is the impact of barriers on market strategies of entrants? Are early and late entrants affected in different ways?

Design/methodology/approach – A model and propositions are developed-based on a review of previous research. The model applies the contingency perspective and company cases exemplify the model.

Findings – It is proposed that a firm that enters a market late and faces extensive barriers would choose a broader product/market scope and differentiate its products to a larger extent than an early entrant. It is also proposed that incumbents’ market strategies indirectly affect the market strategy of an entrant firm as incumbents’ market strategies interact with barriers, and the effects are due to entry timing.

Research limitations/implications The study contributes theoretically as it extends current knowledge of the impact of barriers to entry on strategy. Management of entrant firms are advised to strive for a fit between barriers and market strategy and consider the propositions.

Originality/value – The model and the propositions concern barrier effects on two key components of the nmrket strategy of an entrant firm: product/market scope and product differentiation. Another important value is that the model accounts for interactions between incumbent strategies and harriers to entry, and effects on the market strategy of an entrant firm.

Keywords Market entry, Marketing strategy, Competitors

Paper type Literature review

Introduction

Barriers to entry have been a popular field of research since the seminal work of Bain (1956). Barriers are obstacles preventing entrant firms from being established in a particular market (Porter, 1980). However, despite the practical and theoretical importance of the matter, we still have only limited understanding of the impact of barriers on the market strategy of an entrant firm.

A deeper empirical exploration of the issue calls for a reliable model that clarifies expected relationships. An empirical example is the comprehensive work that takes place within the European Union in order to create unified rules for international competition and reduce the impact of barriers originating from government regulations.

Industries such as telecommunications are subject to these unification processes (Pehrsson, 2001). A general aim is to encourage the establishment of both domestic competitors and competitors stemming from other countries (Karlsson, 1998). But what is the expected impact of barriers on market strategies of entrants? Are early and late entrants affected in different ways?

In theoretical terms, we need further knowledge of a relation between conditions external to the firm and the firm strategy, and, therefore, application of the contingency perspective (Hambrick, 1983; Peteraf and Reed, 2007) is appropriate. The central view is that a fit between external conditions and firm strategy provides a basis for competitive advantage and high performance (Miller, 1996).

According to the review by Peteraf and Reed (2007), an earlier central criticism of contingency theory was that contingency research was reductionist (Meyer et aL, 1993), and empirical models did not account for the impact of interactions among central elements. However, recent studies on internal alignment focus on interaction effects among firm attributes and impact on firm performance (Kauffman, 1993; Levinthal, 1997). Yet, we still have very limited knowledge of interactions among external conditions and the impact on firm strategy.

This paper applies the contingency perspective and focuses on the impact of barriers to entry on the market strategy of early and late entrants. The purpose is to review previous research and to propose a model for the impact of barriers on strategy where product/market scope and product differentiation are central strategy components. The resulting model addresses external firm conditions and proposes direct effects of exogenous and endogenous barriers and indirect effects of incumbents’ market strategies. These constitute the frame for barriers that originate from incumbents’ behavior, and incumbent strategies assumingly interact with barriers to entry.

Although, for example, the performance impact of barriers to entry has been widely investigated (Marsh, 1998), only a few studies have focused on the impact on the market strategy of entrant firms. Robinson and McI)ougall (2001) studied entrants and found that the negative performance effects of three barriers (scale effects, capital need, and product differentiation) were particularly important when the product/market scope was narrow. Further, Pehrsson (2001) observed that deregulation in the telecommunications industry caused adjustments of the product/market scope of market entrants. Finally, Han et a!. (2001) and Salavou et at. (2004) found that a need for capital stimulated the mnovativeness and product differentiation of entrants.

We therefore need to continue to study the impact of barriers on the product/market scope and product differentiation of market entrants. More precisely, there is a lack of knowledge of direct and indirect barrier effects on entrants’ product/market scope and product differentiation. The fact that competitors may constitute a primary source of barriers has largely been neglected, and incumbents’ market strategies most probably indirectly affect the strategy of an entrant firm. Competitors are crucial here as they demonstrate certain market strategies and thereby create customer loyalties and other barriers (Porter, 1980). Also, the literature indicates that the effects are due to entry timing Karakaya and Stahl, 1989), and the effects on the strategy of an early entrant may not be the same as those for a late entrant.

The paper is organized in this way: In Section 2, I review previous research on barriers to entry and the strategy impact of barriers; in Section 3, I present the model and propositions about relationships in the model; Section 4 presents illustrative company cases; conclusions and implications follow in Section 5.

Literature review

This section of the paper first presents important exogenous and endogenous barriers to entry that have been observed by scholars. The section then reviews previous studies on the impact of barriers on product/market scope and product differentiation, and the impact on entry timing.

Important barriers to entry

A barrier to entry can be categorized as either exogenous or endogenous (Shepherd, 1979). Exogenous barriers are those that are embedded in the underlying market conditions and, in principle, firms are not able to control exogenous barriers. On the contrary, endogenous barriers are created by the established firms through their market strategies and their competitive behavior and are thus based on incumbents’ reactions to new entrants’ efforts to become established. However, Gable ci a!. (1995) observed that frequently the barrier types are mutually reinforcing, and they may be difficult to interpret.

Table I lists important barriers to entry that have been observed in the literature, with studies cited by author and publication date.

As regards the exogenous barriers, incumbents’ cost advantages are considered important by several authors (Gable et al., 1995; Han et al., 2001). This barrier means that incumbents may possess absolute or variable cost advantages, forcing the entrant firm to achieve scale effects and low costs. Incumbents’ product differentiation (Pehrsson, 2004; Schlegelmilch and Ambos, 2004) is another important barrier as it creates loyalties and relations among buyers and established sellers, and accompanying obstacles for the entrant trying to access customers Gohansson and Elg, 2002).

Furthermore, the extensive need for capital in order to be firmly established in a market is an important exogeneous barrier emphasized by many authors (flarrigan, 1981; Siegfried and Evans, 1994), and the importance is also valid for customers’ switching costs (Gruca and Sudharshan, 1995; Karakaya and Stahl, 1989). This barrier is due to the costs that any potential customer faces trying to switch from one supplier to another. For example, costs may be allocated to employee retraining or changes in product design.

Available distribution channels might not be anticipated by the entrant firm, or they may be controlled by competitors, creating customer access obstacles (Han el al., 2001; Pehrsson, 2004). Other barriers may include incumbents’ brand loyalty Q<rouse, 1984), costs independent of scale (Karakaya, 2002; Porter, 1980), government policy (I)elmas et a!., 2007; Russo, 2001), number of competitors (Harrigan, 1981), seller concentration (King and Thompson, 1982), and need for research and development (Schmalensee, 1983) including costs for adaptating technology to local market conditions (Pehrsson, 2004).

Endogenous barriers are created by the competitive behavior of incumbent firms in accordance with their market strategies. Important endogenous barriers may originate from excess capacity. This is generally accompanied by increased advertising or promotional activity (Demsetz, 1982; Gable el aL, 1995) or pre-emptive pricing resulting in price competition (Guiltinnan and Gundlach, 1996; Simon, 2005).

T A B L E

It is thus appropriate to view endogenous barriers as established firms’ reaction to new entrants (Karakaya and Stahl, 1989; Yip, 1982). In fact, incumbents may deter the entry of new comers simply by creating expectations of fear for the incumbent’s post-entry reaction (Karakaya and Stahl, 1989).

However, Gable et a!. (1995) found that exogenous and endogenous barriers are mutually reinforcing. They studied entry barriers in retailing and found that incumbents frequently increased advertising and sales promotion when reacting to market entrants. These measures enhanced the degree of product and service differentiation attributed to the incumbent, while the measures also provided a method for an existing retailer to increase the costs of entry to a potential competitor. The observed endogenous barriers of increased advertising and sales promotion thus reinforce the exogenous barriers of capital need and product differentiation.

Further, a number of studies (Karakaya, 2002; Karakaya and Kerin, 2007; Karakaya and Stahl, 1989; Siegfried and Evans, 1994) have explored the relative importance of individual barriers. Karakaya (2002) examined the importance of 25 potential barriers to entry in industrial markets. The majority of the executives in the survey considered the most important barriers to be incumbents’ cost advantages and the need for capital to enter markets.

The impact of barriers on strategy

Researchers have studied the impact of barriers to entry on two strategy components, namely product/market scope (Bonardi, 1999; Delmas and Tokat, 2005; Haveman, 1993; Pehrsson, 2001, 2007; Robinson and McDougall, 2001), and product differentiation (Delmas ci at, 2007; Russo, 2001; Schlegelmilch and Ambos, 2004) including innovativeness (Han ci at, 2001; Salavou ci at, 2004). Table TI summarizes key findings of the studies of strategies of market entrants and incumbents.

As regards product/market scope, Pehrsson (2007) studied perceptions of expansion barriers in 191 subsidiaries of incumbent Swedish manufacturing firms in Germany, the United States and the UK. I-Ic found that the impact of balTiers was due to the breadth of the product/market scope of the firms. Hence, obstacles to access customers affect performance in a negative way if the firm has a narrow product/market scope. One reason why the obstacles are not significant if the scope is broad may be that different customer types and delivered products in this context are associated with more degrees of freedom in choosing customers. Problems in accessing a certain customer type may thus be balanced against limited problems regarding other types.

Robinson and McDougall (2001) established a similar pattern. They studied the moderating effect of product/market breadth on the relationship between entry barriers and performance of 115 new ventures. Three barriers were closely studied:

economies of scale, capital need, and product differentiation, It was found that the negative effect of capital need on return Ofl sales was smaller for ventures pursuing a broad scope. Further, the negative effects of all barriers were smaller for broad-scope ventures as regards shareholder wealth.

Government policy changes manifested by, for example, deregulation or other institutional changes stimulate adjustments of the product/market scope of incumbents (Bonardi, 1999; Delmas and Tokat, 2005; Haveman, 1993; Pehrsson, 2001). Haveman (1993) showed that many firms in the savings and loans industry had expanded into new areas as a result of deregulation. Further, Pehrsson (2001) found that choices of customers made by both incumbents and entrant firms followed deregulations in the British and Swedish telecommunications industries.

As regards the product differentiation component of market strategy, Han el al. (2001) and Salavou et al. (2004) found that market entrants’ innovativeness reduced the impact of capital need. A finn’s innovativeness reflects its way of pursuing product differentiation relative to competitors (Kustin, 2004).

The literature also addresses changes in barriers to entry due to deregulation and their effects on rncuinbents’ differentiation Dehnas el aL, 2007; Russo, 2001; Schlegelmilch and Ambos, 2004). Delmas et a!. (2007) observed a variety of differentiation efforts in response to deregulation in the US electric utility industry, while Schlegelmilch and Ambos (2004) studied strategic options in such industries. In particular, Russo (2001) found that technology differentiation was a common effect of deregulation in the utility industry. Delmas et a!. (2007) advocate that, in fact, differentiation is common in industries that is subject to deregulation.

The impact of barriers on entry timing

Makadok (998) and Pehrsson (2004) underscore that the entry timing advantages of first- and early-movers seem to be resistant to erosion by the entry of additional competitors in a market. Once a new competitor has entered the market, it is difficult to match the performance of the incumbents due to extensive customer loyalties established previously. For the entrant firm this creates severe obstacles to customer access.

Karakaya and Stahl (1989) studied the effects of barriers on the timing of market entry of 49 firms delivering industrial goods and consumer goods. The researchers particularly found that switching costs of potential customers is perceived as more important for late entry than early entry in both industrial goods and consumer goods markets.

This finding supports the notion that late market entrants will face extensive obstacles to access customers due to previous loyalties between sellers and buyers.

A model of the impact of entry barriers on strategy

The model presented in this section proposes relationships between barriers to entry, incumbents’ market strategies and the market strategy of an entrant firm (Figure 1). The model applies the contingency perspective Hambrick, 1983; Peteraf and Reed, 2007) and proposes that an entrant firm’s market strategy is contingent on the external conditions of barriers to entry (P12 in Figure 1). It is also assumed that competitors constitute a main source of barriers; therefore, the model proposes indirect effects and interactions between incumbents’ market strategies and barriers (P3). Further, entry timing is important; the propositions suggest that strategies of early and late entrants differ.

This section first defines the key concepts of the model and continues with motivations and presentations of the propositions.

The concepts in the model

The term “barriers to entry” stems from industrial organization literature and refers to obstacles that firms have to face when they try to establish themselves in a market (Porter, 1.980). Advantages of incumbent firms established earlier correspond to the extent to which the incumbents can raise their prices above a theoretical equilibrium without attracting other firms to enter the market (Bain, 1956). Barriers are exogenous or endogenous and are mutually reinforcing (see the literature review above).

Entrant firms and incumbents demonstrate certain market strategies. Miller (1987) found that the dominant content components of strategy were product/market scope, product innovation, differentiation, and cost control. Product/market scope corresponds to the breadth of business activities and is manifested by the breadth of the range of product types and customer types. As product innovation is a way of differentiating the product in relation to competing products, I include innovation in product differentiation (Kustin, 2004). Further, as cost control is an ingredient of price, and customers are generally more concerned with prices than firm costs, prices are frequently subject to differentiation (Porter, 1980). rrherefore product differentiation in the model also includes pricing.

However, product differentiation does not only refer to the physical product core. Usunier (1993) suggests that services linked to products such as after-sales services are central to differentiation, and Pehrsson (2006) further emphasizes flexibility attributes. Th attributes combine with other attributes in order to meet individual customer needs, and include, for example, solutions to customer problems and distribution features.

Differentiating products in relation to products of competitors may thus give the firm competitive advantages. In essence, Porter (1980) convincingly argues that differentiation is a way of creating layers of insulation against competitive warfare and increases the odds of achieving high financial performance.

Direct effects of barriers to entry

Pehrsson (2007) and Robinson and McI)ougall (2001) found that the effects of barriers were less severe if the product/market scope of a market entrant was broad. Based on the findings, the researchers argue that product/market breadth of market entrants generally moderates the relationship between entry barriers and performance.

Theoretically, a market entrant that has to face extensive barriers to entry would prefer a broad product/market scope. In that way, the entrant may be able to exploit the degrees of freedom that accompany the broad scope, and balance obstacles in accessing a certain customer type against obstacles relating to other types.

However, research has shown that late market entrants tend to be exposed to more comprehensive barriers than early entrants (Makadok, 1998; Pehrsson, 2004). In particular, customer loyalties and customers’ switching costs (Karakaya and Stahl, 1989) constitute key competitive advantages of early entrants. A late market entrant would, therefore, theoretically have to face more severe obstacles in trying to access customers than would an early entrant:

P1. A firm that enters a market late and has to face extensive barriers will chxse a broader product/market scope than an early entrant.

In accordance with the results of Han el at (2001) and Salavou el at. (2004), market entrants frequently use product innovations to overcome market entry barriers. As innovativeness manifests product differentiation, it is logical to propose that a market entrant may use product differentiation in order to respond to barriers, and that comprehensive differentiation efforts follow extensive barriers. As a late entrant is theoretically exposed to more extensive barriers than an early entrant, this leads to the second proposition:

P2. A firm that enters a market late and has to face extensive barriers will differentiate its products to a larger extent than an early entrant.

Indirect effects of barriers to entry

P1 and P2 do not pay attention to indirect effects, crucial interactions among barriers to entry and other important conditions external to the entrant firm. However, we can expect that barriers interact with incumbents’ market strategies. This expectation relies on the necessity of observing competitors as they pursue certain market strategies, and are able to create customer loyalties and other barriers (Porter, 1980). If we pay attention to incumbents, a strategy that promotes the development of brand loyalty, for example, focuses on a factor that create barriers (Krouse, 1984).

Further, entry timing advantages of first- and early-movers (Makadok, 1998; Pehrsson, 2004) generally stem from the firms’ opportunities to penetrate potential customers, start to differentiate products, and develop customer relationships. If successful, the customer relationships and accompanying loyalties become effective barriers to competition. Theoretic-ally, late entrants therefore have difficulty matching the performance of the early entrants. We may therefore propose that the interaction affects early and late entrants in different ways:

P3. Incumbents’ market strategies indirectly affect the market strategy of an entrant firm as incumbents’ market strategies interact with barriers to entry. The effects are different for early and late entrants.

Illustrative cases

Deregulation and unification of rules pertaining to firms operating telecommunications networks caused operators to reconsider their market strategies in Europe (Pehrsson, 2001). Unlike many other European countries, Sweden has never legalized a monopoly for the establishment of telecommunications networks or for the offering of services.

However, Televerket (the Swedish public telecommunications administration) historically had a monopoly-like hold on many sectors of the market. This organization was converted in 1993 into a company group with a parent fIrm, Telia. As there are no regulations protecting Swedish interests or restricting foreign operators from establishing themselves in the country, many firms have entered the market.

Any firm with a desire to enter the market will have to face the barrier of capital need in terms of the arrangement of infrastructure. For example, Tele2 entered the market early and addressed this need for capital by cooperating with the Swedish State Rail Administration. The background for Kinnevik’s establishment of Tele2 is that Kinnevik had gained experience from mobile telephony in the USA (NetCom Systems, 1994). Parallel with these activities, preparations began within traditional telecommunications for voice and data in the 1980s. A gateway for data traffic was opened in 1986, and in 1989 an agreement was concluded with the Swedish State Rail Administration for joint investments in a fiber optic network. Tele2 was formed in 1987 with the intention to offer stationary telephony primarily to households based on low prices. When the deregulation of the telecommunications market accelerated in 1993, Tele2 was able to act fast and reached second place after the incumbent, Telia.

I)otcom l)ata & Telecommunications entered the Swedish market late and had to face the extensive barriers caused by the dominance of the incumbent and early entrants. By the end of the 1990s, Dotcom was the only operator in the Swedish market with telecommunications operations that were not part of the original corporate core business Dotcom Data & Telecommunications, 1995). The product/market scope was dominated by local data networks and included also stationary telephony, leased lines,

office exchanges, extensive communications systems, support systems and so on. Middle-sized companies, large companies, and public administrations were the main target groups.

In sum, the case of Dotcom Data & Telecommunications illustrates P1. The firm was exposed to extensive barriers due to the firm’s late market entry and chose a broad product/market scope. In that way, the firm was able to exploit the degrees of freedom that accompanied the broad scope, and balance obstacles in accessing a certain customer type against obstacles regarding other types.

Further, Dotcom Data & Telecommunications tried to avoid price competition and, instead, strived for long-term customer relationships. As there were six phases of the delivery chain (analysis of needs, systems design, installation, education, service, and financing) there were many options to conduct product differentiation. A comparison with the limited low-price differentiation of Tele2 illustrates P2. However, in accordance with P3, both entrants had to face the barriers caused by the incumbent’s cTelia’s) strategy of keeping its market dominance and loyal customers.

Conclusions and implications

Despite the limitation that there may be more important external conditions beyond incumbents’ market strategies that interact with barriers to entry, we are now able to conclude the a firm that enters a market late and has to face extensive barriers probably would chxse a broader product/market scope and differentiate its products to a larger extent than an earlier entrant. Also, it is proposed that incumbents’ market strategies indirectly affect the market strategy of an entrant firm as incumbents’ market strategies interact with barriers, where the effects are due to entry timing. In sum, the model extends our knowledge as it accounts for the direct impact of barriers to entry on product/market scope and product differentiation, and specifies central conditions external to the entrant firm. Also, the model accounts for entry timing effects.

In accordance with the contingency perspective management of entrant firms would be advised to strive for a fit between barriers to entry and market strategy and thereby bear in mind the proposals put forward in this paper. Of importance are not only direct effects of barriers on product/market scope and product differentiation, but also the way incumbent strategies interact with balTiers. It would also be advisable for each firm to evaluate the relative importance of barriers and acknowledge that a late entry is generally accompanied by more extensive barriers than an early entry. Further, as exogenous barriers and endogenous barriers are often mutually reinforcing, attention needs to be paid to combined effects.

Further empirical research should be conducted in terms of applying the model developed in this paper. A suggestion for future research is to explore how management perceives barriers to entry, and how this perception contributes to the emergence and sustainability of competitive advantage. Also, it would be interesting to explore managerial knowledge of barriers in early and late phases of market entry.