This article asks what’s the threat of entry within Porter’s five forces model? It explains the entry threat, how to detect and analyse it within your industry. You may have a tremendous competitive advantage. An advantage that offers years of growth and success. What about your threat of entry? Those new competitors you know nothing about.
Porter’s five forces model
Michael Porter argues that five forces influence competition and long term investments. The five forces are the:
- Threat of entry
- Bargaining power of suppliers
- Bargaining power of bias
- Intensity of rivalry
- Threat of substitution
It’s essential that you are strategically positioned within your industry. Firstly, to defend yourself from these forces. And then go on the attack by manipulating them to your advantage. One of Porter’s five forces is what is called the threat of entry.
Threat of entry
Answer this question. How easy is it to enter your industry? Look at the recruitment industry. This industry is a really competitive sector, but it’s incredibly easy to enter. All you need is an email address, a phone, relatively little experience and lots of confidence. But the manufacturing of satellite sun shield covers is much less competitive. So it would make sense to enter this satellite sun shield covers market and hoover up the business.
How easy was that? Sorted, order your villa next to a sun-kissed Bahamas beach. Hang on though it’s never that easy is it? To enter this market, you will need expensive equipment to participate. Abide by lots of rules and regulations. Unlike recruitment, it helps if you have a good quality degree, or PHD, integrity and some experience.
You may want to operate in an industry where the threat of entry is low. A monopoly would be perfect, of course. If you can find one, you can get away with charging the prices you want. Very hard to find a monopoly as your government usually has a say about that sort of thing.
Cost of scale and investment requirements
When looking at your threat of entry, look at the economies of scale that can exist your business functions. Large scale manufacturing or selling brings with it cost advantages. Per unit costs of the product fall. If you can produce in quantity, the more you will benefit. It’s a significant barrier to entry when existing companies have this advantage. A new competitor will have to try to match the production and sales levels, to be anywhere near achieving the similar cost advantages existing companies enjoy. This may not be possible at the initial stages of an expansion.
If your industry needs substantial capital investment to enter, then this is also a significant barrier to entry. To enter, they will need the resources to make a high initial investment. Then there are the functions such as production, marketing, distribution administration and product differentiation. Do you and your existing competitors have trusted brands? Do they attract great customer loyalty already? A loyalty which may be difficult to replace. But never impossible to replace. Think back how much we loved a Blackberry phone not that long ago and then Apple came along. Even then, Blackberry and companies like Nokia had created a very high barrier to entry.
Industries like yours may operate in sectors where there are high upfront costs. Like the need to build a large production plant or spending lots of money on R&D, it could scare some competitors off.
Distribution and suppliers
Likely, you have already got a distributor and suppliers network if you are established in an industry. Both of these tend to be necessary for a new business. Existing suppliers will have contracts and loyalties you. And it won’t be easy to form relationships with them. But a new competitor will need distribution channel access. They will need to invest more time and money than you to establish distributors.
Barriers to exit
An interesting barrier is the barrier to exit. If it is challenging to get out of an industry, it will deter entry in the first place. With a no easy exit if things don’t work out may force a competitor to carry on within a market where it’s struggling. This trading could seriously risk the future of the company. So a company could see that as an unacceptable risk and choose not to enter the market in the first place.
Another aspect of determining is how easy it is to convince a customer to switch from one product to another. Think of the switching costs. Things such as retraining, testing, product redesign. Going back to the iPhone example. The key to the iPhone for most customers is that whatever iPhone you buy you don’t need to relearn a new mobile interface. Same with Samsung users and other Andriod based systems. Is there a cost of switching for a customer if they decide to move from you to another product or service? High switching costs for a new entrant may not be able to create a means of removing these.
Another barrier to entry for those competitors who have come late to the party is that they will face cost disadvantages. They need to learn and understand the market quickly. And they will experience less favourable access to raw materials. They will need to recruit and pay top dollar for people to move over to you. Sales and Marketing have to make a significant impact. That costs money, especially if your competitor has a tremendous well-known brand.
Then there is the interference that will cost a new entrant to enter a market. A cost that does not have to be money. A government’s policies can completely deny you to access to a specific industry. For instance, setting up a business on YouTube has a very low barrier to entry. It’s easy for someone to start a channel from scratch without any prior experience. Therefore competition on YouTube is very high.
Taking government policies into account as a barrier to entry onto YouTube is still very low. Until you want to sell into China and then the barriers of entry are impossible to climb. At the time of writing YouTube is banned in China.Then are other influences, like how countries do business. Entering the Russian natural gas market will have many challenges. Especially if you are not on the right side or partnered with trusted sources. Get it wrong, and it could soon become an episode of McMafia, resulting in a rapid and perhaps permanent exit.
Types of entry threat
There are many types of entry threat that could influence your market. A company from outside the industry takeovers an existing company. Smashing through the traditional barriers to entry. This will bring a new threat to your business by offering new and innovative expertise to your customers. An increase in demand could result in price increases. Allowing a new entrant to make use of this increase and offset any high market entry costs. There is also a risk that an existing company diversifies its product into other categories. And even companies within the industry could control how a new company enters its market. The threat of entry in your industry can be mitigated by the companies’ retaliation already within the industry. Think Russian gas fields again.
Questions to determine barriers
Here are some questions to answer to help you determine barriers associated with entry into a new market or your current market:
- What are the switching costs for customers? Are they significant?
- How is easy is it to align with and access existing distribution channels?
- Will the location be a problem?
- Does profitability depend on economies of scale?
- What’s the required proprietary technology for entry?
- What proprietary or specialised raw material are needed to enter?
- Are government regulations, laws and policies complicated or straightforward?
- Will existing business offer retaliatory action against a new entrant?
- Are products the products in your industry different, or are they generic?
- Are brand names established, recognisable and robust?
- Will a new entrant need high initial capital investment?
A competitor will only enter an industry if it forecasts the potential reward for being in it is greater than the cost of overcoming entry barriers. And the cost of any retaliation that is likely to happen within the industry.
This article asked what’s the threat of entry within Porter’s five forces model? It explained the entry threat, how to detect and analyse it within your industry. You may have a tremendous competitive advantage. But it’s important to understand your threat of entry.