Entry and exit

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Entry and exit

• By
• A.V. Vedpuriswar

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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

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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.
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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 incumbents 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.

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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 incumbents profits.
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• 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.

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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.
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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.

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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 firms reputation or
predation through announcements, limit pricing
and holding excess capacity change the entrants
expectations of post entry competition.
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Judo strategy

• Sometimes, smaller firms and potential entrants
  can use the incumbents 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 incumbents profitability, the incumbent
  might think twice about incurring large losses to
  drive the entrant from the market.
• Recall the Netscape Microsoft war.

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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.