In the corporate world, a firm would be more profitable if there is lesser intensity from the rivalry among existing firms, the lesser danger of potential entrants and higher barriers to entry, lesser substitutes for the firm’s products and a weaker bargaining power of the consumers and suppliers. Competitive incumbent firms or existing businesses in a particular market adopts strategic entry deterrence to discourage potential entrants from entering into competition in the market. These actions from the existing companies create and strengthen barriers to entry for the industry for new entrants. However, this course of action causes market to lose competition and some might even be illegal. Not all industries and not all companies respond in the same way, the strength and aggression of the response varies accordingly to the current market trends, conditions and consumer behaviour. In this essay, we will discuss on several strategic actions taken by the incumbent firms to create, maintain or increase deterrence on new and potential entrants and thereafter, analyzing the credibility of each action.

There are many types of barriers to entry into a market, including factors like high capital costs, differentiated product, costs of switching, distribution network, economies of scale, suppliers, barriers to exit and legal and government created barriers.

High capital cost: In an industry that demands a larger capital investment during the starting up process, it will act as a barrier to entry for most potential entrants unless those who have a competitively high initial capital investment to start.

Differentiated product: A highly differentiated product compared to the available ones in the market within the same industry would allow the incumbent firm enjoy a strong brand loyalty by the consumers. New entrants would have to invest a lot of capital to create a product with unique and new features that the benefits are better than those available in the market. On top of that, more efforts from the new entrants would be required to break the existing brand loyalties and shift it to the new untested entrant.

Costs of switching: When a consumer switches their preference of product from one to another is termed switching cost. If the cost is too high for the consumer to undertake to even test the new product, there would be no chance that the new firms’ products are going to work out. Offering significant advantages to counter the switching costs would be at their own expenses which might incur too much of a cost.

Distribution network: As the long-staying incumbent firms have already established a strong relationship with their distributors, new entrants would need to invest extra in order to access these distribution channels as they will definitely need some distributors and that might affect their income and expenses.

Economies of scale: When a company manufacture or sell at a very large scale, incumbent firms would be able to enjoy cost advantage because per unit costs of the product fall, the more the company produces in quantity, the higher the benefits. New entrants would have to try and match the scale to achieve the same cost advantage as the incumbent firms which might not be possible at the initial point.

Suppliers: Existing or new firms would definitely need suppliers in any form and they are vital to the operations of a new business. Incumbent firms have already created contracts, contacts and loyalties with the existing suppliers and it would be hard to form new relationship from the new entrants.

Barriers to exit: In a company is not able to leave a competitive market easily in an event that the business does not work out, it would have to stay and compete even if the business is losing revenue and income, so the company may not even choose to enter the market in the first place.

Legal and government created barriers: From a bigger picture, government and regulatory requirements such as licenses and permits would act as a strong barrier to entry. That would include laws from government governing ways to conduct businesses in the market that would conflict with a company’s practices in other countries.

However, not all possible barriers apply to all industries and companies. It is up the new entrant’s decision and capital resources to battle the entry into the market. Competitively, it is also up to the incumbent firm whether or not to respond to the new entrant using strategic entry deterrence. Below are some examples of how incumbent would react to new entrants.

Limit pricing
A firm would choose to produce a larger monopoly output of products and selling them at a lower price than the competitors would be able to sell at if new entrants were to enter into the market is termed limit pricing. If limit pricing was processed out well, the incumbent would be able to affect the market price and would be able to own a larger selling share in the market and making supernormal profits, and leaving lesser openings for the rival. But not all incumbent firms are able to resort to limit pricing unless they have already been going through higher than normal profits and have the capacity to magnify their production at low cost increment. It is only a good and credible strategy if the profits earned from limit pricing are higher than the cost of risk if the new entrant were to be able to compete in the market after entering.

Pre-emptive deterrence
Incumbent companies might try to reduce the new entrant’s outcome by deterring entry into market, the expected payoff would depends on the new entrant’s expectation of the amount of customer they think they might have, existing companies might try to round up the faith of their customers as a solution. When consumers are faithful to a particular brand, they buy from the same manufacturer repeated rather than other suppliers, true brand loyalty might even occur when consumers think very highly of a certain brand, going out of their way and are willing to pay higher price for that certain brand. Brand loyalty is a barrier to entry for new entrants as consumer would be less likely to consume the new entrants’ products as they have not tried it out yet. New entrants would have to incur expensive and additional cost raise awareness of consumers in the markets of their products by advertising and even have to desperately reduce the price of their products so that consumers in the market are willing to give it a try at least and this might be too expensive to enter, causing a large sunk cost that will prevent the new firms from entering.

Predatory pricing
In the short run, predatory pricing reduce price of the incumbent firms’ good dramatically, reducing profit margins and causing profits to decline sharply. There are tests to analyze on whether the pricing is predatory, Areeda-Turner test determines a price below average variable cost is presumed to be illegal or predatory. If a monopoly is having supernormal profits, it attract new firms into the industry, then the incumbent firm will finance a price war with their significant savings, the new firm would be unable to gain profit and be forced to leave the market. The incumbent company regains its monopoly power and the predatory pricing discourages other firms from entering again. After the weaker entrant has left the market, the surviving business can raise the prices above competitive levels to generate revenues and profits in the future in order to offset the losses made during the price war with the previous entrant, known as recoupment. However, predatory pricing would not be efficient if the rivals are stronger than the incumbent firm’s expectation, it causes a prolong of losses by the incumbent firm and could result in the initiator not being able to endure the short term losses due to poor estimation and foresight. Thus this strategy is only viable if the incumbent firm is substantially stronger than the new entrants and that the barriers to entry are considerable high to prevent new entrants from coming in repeatedly and elongating the duration of the price war.
Product differentiation
A marketing strategy that companies utilize often to distinguish its products of goods or services from similar products that their rival companies sell could really improve the business of the firm. When a company uses a differentiation strategy that aim and focus on the cost value of the product against similar products in the market, it creates a perceived value among consumers and potential customers. It would also allow the incumbent firms to be different which reduce competition and making it possible to reach new segments in the market. A production differentiation strategy focusing on design and quality of the company’s product would create a perception that there is no substitute available in the market. At the same time, if a new entrant were to enter the market and tries to match the product, they would have to invest quite a sum of money on packaging of their product or an advertising theme to bring out their new products to their potential customer who are loyal to the existing products of goods or services that the incumbent companies have to offer. Knowing that the new entrants would have to spend a big sum of money to endorse or advertise their new but similar products and going against the faith of the consumers with the existing product, they might reconsider to enter the market if the start up capital or resources is insufficient to go against the incumbent’s strategy.

Signalling
The existing firms would have an advantage of being able to initiate any actions first and is able to influence the new entrant’s next move. Assuming imperfect information that the incumbent firm’s cost are only privately known, new entrants could only make assumptions about the existing firm’s cost through publicly available share price or the price of their goods or services. The incumbent would be able to manipulate their price appropriately to “mislead” the new entrants by charging a price less than the monopoly level. Limit pricing Will send a signal of potential lack of substantial profits as low cost incumbent can signal its efficiency to a potential new entrant through lowering price, discouraging the new entrants by making them think that their entry would be unprofitable. Signalling have to be delivered effectively to be credible, a low cost incumbent firm must be able to show that they are able to undergo and overcome lower profits over an extended period of time which it would not be able to if they had higher cost, any signal sent requires a strong back up of actual ability to withstand and last over a longer period of time

Takeover
An interested company makes a bid for another company to partially or fully acquire the management and operations of the target company. If the full takeover goes through, the acquiring company becomes responsible for all of the target company’s holdings, operations and debts. When the target is a publicly listed company, the acquiring company will make an offer for all of the target’s outstanding shares. There are several types of account;
Friendly takeovers refer to the acquiring of the target company after an approval given by the management where both company’s share holders and board of directors agrees on consensus that the takeover would be beneficial.
Hostile takeover allows the acquiring bidder to take over the target company even though the target company’s management is unwilling to agree. The takeover is considered “hostile” if the target company management declines the offer but the acquiring company still continues to pursue it.
In the case of a new entrant, the incumbent firm might turn hostile and resort to forceful takeover of the new firm if the incumbent firm is strong and resourceful enough.

Doomsday device
A doomsday device is a hypothetical construction, and in relative to economical term, it is a threat against any potential entrant. The threat would be credible enough if the incumbent firm has a good reputation or the firm could prepare condition that makes it favourable to fight in if the potential entrant enters. If the barrier to exit within the market is relatively low, an incumbent firm fighting against an efficient rival may find it more feasible to exit the market rather than to compete against the rival. Thus, to carry out the threat suitably, the incumbent firms would raise the cost of exit superficially.
For example of increasing the cost of exit would be in the aspect of having high sunk costs which are normally in firms that require a tremendous amount of capital to start up, maintain and eventually folding the business in any unfortunate event. Taking railroad companies as example, the high sunk cost of laying a whole network of railway makes it likely that a rail company owner will be willing to fight a more expensive price war than a potential entrant rival with lower sunk costs. In comparison to the highest extent, if the incumbent firms sunk costs are really high, any entry by any potential entrant would eventually have to suffer a mutually destructive outcome.

Conclusion

In conclusion, give the nature of businesses there is always a threat of new potential entrants as it is still not very costly to enter the market to set up businesses and operations. There is also no extra and expensive costs incurred to set up any physical stores and location. Furthermore, traditional established physical stores are slowly replaced by the younger generation of entrepreneurship of bringing their businesses online for easier and more accessible reach by consumers. Online retailing would bring a more substantial consumer base to enjoy the economies of scale.

References

Tejvan Pettinger (2012) “Predatory Pricing” http://www.economicshelp.org/blog/glossary/predatory-pricing/

Areeda P. E., & Turner, D. F. (1975). “Predatory pricing and related practices under section 2 of the Sherman Act” Harvard Law Review.

Thomas S. Gruca & D.Sudharshan (1995) “A framework for entry deterrence strategy: The completive environment, choices, and consequences” Journal of Marketing, Entry Deterrence Strategy

David D. Friedman and Milton Friedman (1986) “Price Theory: Hard Problems: Game Theory, Strategic Behavior, and Oligopoly” South-Western Publishing Co.