david bryce © 1996-2002 some portions adapted from baye © 2002 threat of entry: factors that...

David Bryce © 1996-2002Some portions adapted from Baye © 2002David Bryce © 1996-2002Some portions adapted from Baye © 2002

Threat of Entry: Factors that Increase Cost for New Entrants

Threat of Entry: Factors that Increase Cost for New Entrants

MANEC 387MANEC 387

Economics of StrategyEconomics of Strategy

MANEC 387MANEC 387

Economics of StrategyEconomics of Strategy

David J. BryceDavid J. Bryce


The Structure of IndustriesThe Structure of Industries

Competitive Rivalry

Threat of newEntrants

BargainingPower of

Customers

Threat ofSubstitutes

BargainingPower of Suppliers

From M. Porter, 1979, “How Competitive Forces Shape Strategy”


Entry and Market StructureEntry and Market Structure

• Concentration and product differentiation determine market structure

• An industry is concentrated when there are relatively few, powerful firms

• The degree of price competition is directly proportional to the number of rivals in the market

• If firms are to earn economic profits in the long-run, something must prevent entry

• Concentration and product differentiation determine market structure

• An industry is concentrated when there are relatively few, powerful firms

• The degree of price competition is directly proportional to the number of rivals in the market

• If firms are to earn economic profits in the long-run, something must prevent entry


4

143214 i imsmsmsmsmsC

Measuring Industry ConcentrationMeasuring Industry Concentration

• Industry concentration may be measured as follows:– Four firm concentration ratio (C4)

– Herfindahl-Hirschman index (HHI)

• Industry concentration may be measured as follows:– Four firm concentration ratio (C4)

– Herfindahl-Hirschman index (HHI)

T

i imsHHI1

2000,10

• Limitations: ignores foreign imports (bias upward), ignores local/regional market power (bias downward), and industry definitions.

• Limitations: ignores foreign imports (bias upward), ignores local/regional market power (bias downward), and industry definitions.


Concentration in Selected IndustriesConcentration in Selected Industries

Industry C4 HHI

Breakfast Cereals 83 2446

Computers 45 728

Fluid Milk 21 205

Household Appliances 82 2025

Motor Vehicles 82 2506

Ready-mix Concrete 7 29

Semiconductors 34 414

Soft Drinks 47 800

Snack Foods 63 2619

Tires 73 1814Source: US Bureau of the Census (1997)


Barriers to EntryBarriers 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)


Barriers that Increase CostBarriers that Increase Cost

• Access to capital markets• Proprietary technology (patents, copyrights,

trade secrets)• Know-how (knowledge, routines, capabilities)• Access to raw materials (unanticipated

value)• Geographic locations• Economies of scale/Learning by doing

• Access to capital markets• Proprietary technology (patents, copyrights,

trade secrets)• Know-how (knowledge, routines, capabilities)• Access to raw materials (unanticipated

value)• Geographic locations• Economies of scale/Learning by doing


Defining Economies of ScaleDefining Economies of Scale• A range of economies of

scale exists when average total cost (ATC) declines as output rises.

• A range of diseconomies of scale exists where ATC rises as output rises.

• The Minimum efficient scale (MES) is the smallest output that can achieve minimum average cost.

• A range of economies of scale exists when average total cost (ATC) declines as output rises.

• A range of diseconomies of scale exists where ATC rises as output rises.

• The Minimum efficient scale (MES) is the smallest output that can achieve minimum average cost.

ATC(Q)ATC(Q)

QQ

Econ ofEcon ofScaleScale

Disecon Disecon of Scaleof Scale

MESMES


Sources of Economies and Diseconomies of ScaleSources of Economies and Diseconomies of Scale

• Economies of scale– Indivisibility and the spreading of fixed costs

– plant & equipment, overhead, advertising, inventory, R&D

– Increasing efficiency through specialization

• Diseconomies of scale– Physical limits to efficient size– Limits to managerial cognition—the cost of

complexity– Worker motivation– Distance to suppliers and markets

• Economies of scale– Indivisibility and the spreading of fixed costs

– plant & equipment, overhead, advertising, inventory, R&D

– Increasing efficiency through specialization

• Diseconomies of scale– Physical limits to efficient size– Limits to managerial cognition—the cost of

complexity– Worker motivation– Distance to suppliers and markets


Example: Diseconomies of ScaleExample: Diseconomies of Scale


Economies of Scale as a Barrier to EntryEconomies of Scale as a Barrier to Entry

• Capital costs• Risk and/or inefficient capital markets• Time compression diseconomies• Disproportional marketing costs to

achieve market share equal to MES• High minimum efficient scale relative to

demand

• Capital costs• Risk and/or inefficient capital markets• Time compression diseconomies• Disproportional marketing costs to

achieve market share equal to MES• High minimum efficient scale relative to

demand


Example of High (Relative) MESas an Entry BarrierExample of High (Relative) MESas an Entry Barrier

• All firms produce with an identical technology that exhibits minimum efficient scale of four units.

• How many firms will enter?

• What will the equilibrium price and quantity be?

• All firms produce with an identical technology that exhibits minimum efficient scale of four units.

• How many firms will enter?

• What will the equilibrium price and quantity be?

22 44 8866 1010

22

44

66

88

1010

Price/CostPrice/Cost

P(Q)

MC(Q)

AC(Q)

QQMESMES


Example of High (Relative) MESas an Entry BarrierExample of High (Relative) MESas an Entry Barrier• Two firms produce at

MES=4• (Dis)economies of scale

are steeper than demand and do not justify producing above MES.

• Other firms would enter but must produce at MES

• Four more units lowers price below cost – entry is deterred

• Two firms produce at MES=4

• (Dis)economies of scale are steeper than demand and do not justify producing above MES.

• Other firms would enter but must produce at MES

• Four more units lowers price below cost – entry is deterred

22 44 8866 1010

22

44

66

88

1010

Price/CostPrice/Cost

P(Q)

MC(Q)

AC(Q)

QQMESMES

Rents to each firmRents to each firm


Defining Learning by DoingDefining Learning by Doing

• Variable cost falls as increasing experience generates increasing productivity.

• The traditional learning curve is CN = C1 N- – Where CN is cost of the Nth unit, C1 is cost of the first

unit, N is cumulative volume (Nth unit), and is the rate of learning by doing.

• It is common to assume an 80% learning curve – every doubling in cumulative output generates a 20% cost reduction.– Note that cost falls from $10 to just over $2

after only 100 units in an 80% curve.

• Variable cost falls as increasing experience generates increasing productivity.

• The traditional learning curve is CN = C1 N- – Where CN is cost of the Nth unit, C1 is cost of the first

unit, N is cumulative volume (Nth unit), and is the rate of learning by doing.

• It is common to assume an 80% learning curve – every doubling in cumulative output generates a 20% cost reduction.– Note that cost falls from $10 to just over $2

after only 100 units in an 80% curve.


Learning by Doing as a Barrier to EntryLearning by Doing as a Barrier to Entry

• Early entry provides potentially insurmountable cost advantages

• Learning facilitates fighting the entry of rivals

• Early entry provides potentially insurmountable cost advantages

• Learning facilitates fighting the entry of rivals

AVC(Q)AVC(Q)

Qi Qi

Too flat

AVC(Q)AVC(Q)

Qi Qi

Too steep

AVC(Q)AVC(Q)

Qi Qi

Just Right


“Strategic Management” of the Learning Curve“Strategic Management” of the Learning Curve

• Win the market share battle– highest market share has the highest volume and

cumulative volume growing at fastest rate, descending the learning curve fastest to the lowest cost.

• Price aggressively to increase volume and learning – communicate lowest cost (cost level that will attain)

to marketing to promote sales.

• Win the market share battle– highest market share has the highest volume and

cumulative volume growing at fastest rate, descending the learning curve fastest to the lowest cost.

• Price aggressively to increase volume and learning – communicate lowest cost (cost level that will attain)

to marketing to promote sales.


“Strategic Management” of the Learning Curve“Strategic Management” of the Learning Curve

• Managing knowledge and learning– Incentive systems, bonus plans, zero defect

programs, etc.– Engineering effort (experiments and analysis)– Teamwork– Turnover– R&D practices– Technology transfer practices

• Managing knowledge and learning– Incentive systems, bonus plans, zero defect

programs, etc.– Engineering effort (experiments and analysis)– Teamwork– Turnover– R&D practices– Technology transfer practices

We might concede the market share battle and win the cost warWe might concede the market share battle and win the cost war


Limitations of Strategy on the Learning CurveLimitations of Strategy on the Learning Curve

• Market share does not guarantee substantial cost advantages– What is the cost of market share?– Learning curve flattens with high experience

• “Spillovers” leak knowledge to rivals without full costs of learning

• Short product cycles reduce time to enjoy cost advantages

• Aging equipment can impede continued learning and cost advantages

• Market share does not guarantee substantial cost advantages– What is the cost of market share?– Learning curve flattens with high experience

• “Spillovers” leak knowledge to rivals without full costs of learning

• Short product cycles reduce time to enjoy cost advantages

• Aging equipment can impede continued learning and cost advantages


Summary and TakeawaysSummary and Takeaways

• Barriers to entry increase industry concentration by raising the cost of entry above the benefits of entry.

• Barriers to entry are necessary but not sufficient to ensure firms will avoid price competition

• When firms overcome entry barriers, they must worry that they invite others to enter.

• Barriers to entry increase industry concentration by raising the cost of entry above the benefits of entry.

• Barriers to entry are necessary but not sufficient to ensure firms will avoid price competition

• When firms overcome entry barriers, they must worry that they invite others to enter.

david bryce © 1996-2002 some portions adapted from baye © 2002 threat of entry: factors that...

Documents

david bryce

entry concentration

bryce slide

market structure concentration

entry slide

industry definitions

infant industry protection

threat of entry