When launching an ecommerce business or bringing a new product to market, understanding barriers to entry can make the difference between success and failure. Obstacles—-from high startup costs to entrenched competition—shape how difficult it will be for your business to grow.
For commerce entrepreneurs, the good news is, traditional barriers to entry are lower than those for brick-and-mortars. However, there are challenges in the digital marketplace. This guide will identify potential barriers to online commerce, while offering strategies to overcome them. Get ready to position your business for growth in today’s market.
What are barriers to entry?
Barriers to entry are obstacles that make it difficult for new businesses to enter and compete in a market. These barriers protect established companies and can take various forms:
- Economic barriers: High startup costs, economies of scale, and capital requirements
- Regulatory barriers: Government regulations, licensing requirements, and patents
- Market-based barriers: Brand loyalty, network effects, and control of resources
- Strategic barriers: Predatory pricing, exclusive contracts, and high switching costs
Understanding these challenges helps entrepreneurs identify opportunities in less competitive markets or develop strategies to overcome barriers in their chosen industry.
How do barriers to entry work
Barriers to entry can include government regulations, the need for business licenses, and having to compete with large corporations as a small startup.
While there is no universally accepted list of barriers to entry, generally barriers to entry can fall under three categories.
- Artificial barriers to entry: Artificial barriers to entry refers to barriers that are the direct result of existing firms actions. Frequently, this involves barriers centered around pricing, brand, switching costs, and customer loyalty.
- Natural barriers to entry: This includes high barriers such as network effects, economics of scale, and other natural barriers that are the direct results of a new entrant's new position in the marketplace.
- Government barriers to entry: Barriers to entry related to the government refer specifically to challenges new firms face as a result of government regulations and restrictions. Governments around the world frequently create favorable conditions for particular incumbent firms that can make it challenging for new entrants.
Examples of barriers to entry
Economies of scale in established companies
A large, established company benefits from producing a high volume of products efficiently, resulting in lower fixed costs. This efficiency allows for more cost-effective operations compared to smaller companies with fewer resources. Large companies achieve lower costs through bulk purchasing and reduced overhead by consolidating production under one roof. In contrast, smaller companies struggle to compete with these economies of scale, sometimes avoiding market entry altogether.
Regulatory hurdles
Government-imposed education and licensing requirements present another barrier to entry. For instance, starting an alternative school necessitates substantial investment in various certifications and approvals. This requirement imposes significant capital costs, particularly challenging for new firms with limited cash flow.
Market share and startup costs
Firms with established market share in an industry have a significant advantage over new entrants. New companies face not only high startup costs but also the challenges of business growth. In contrast, existing firms enjoy cost advantages and the benefits of an already established market presence.
Impact on competition and prices
Barriers to entry can negatively impact market competition and pricing. When the playing field is uneven and competition is limited, prices may be unfavorably influenced. This situation often benefits large, monopolistic companies at the expense of new entrants and consumers.
However, barriers to entry are not always completely prohibitive. In fact, many business startups encounter some sort of barrier to entry that they must overcome, whether that's initial investments, acquiring licenses, or obtaining a patent, it’s just part of doing business.
Sources of barriers to entry
Generally speaking, entry barriers come from seven sources:
- Economies of scale: The decline in the cost of operations due to higher production volume, which helps keep fixed costs low. More established existing firms have a significant cost advantage compared to newcomers.
- Product differentiation: The brand strength of the product as a result of effective communication of its benefits to the target market. It can be difficult for new entrants to “break through the noise” in their market.
- Capital requirements: One of the major economic barriers, capital requirements refers to financial resources required for operating the business. Starting a car wash business, for example, is more capital intensive than creating an ecommerce store.
- Switching costs: This refers to one-time costs the buyer must incur for making the switch to a different product. Your product technically may be the better solution, but if the cost to switch is too high, customers often will remain with the solutions existing firms provide.
- Access to distribution channels: Does one business control all of them, or are they open? Shipping, logistics and more are a powerful barrier to entry, incumbent firms use to their advantage.
- Cost disadvantages independent of scale: When a company has advantages that cannot be replicated by the competition, such as proprietary technology.
- Government policy: Controls the government has placed on the market, such as licensing requirements and other required documentation needed to start and grow a business.
Barriers to entry in ecommerce
While ecommerce generally has lower barriers to entry than traditional retail, online businesses face their own set of challenges:
- Digital marketing costs: Paid advertising costs have increased significantly, making customer acquisition more expensive for new entrants.
- Marketplace dominance: Large platforms like Amazon control significant market share, making it harder for independent stores to gain visibility.
- Technical requirements: Building a competitive ecommerce site requires increasingly sophisticated features and integrations.
- Trust building: New online stores must overcome consumer hesitation about purchasing from unknown brands.
Despite these challenges, ecommerce remains more accessible than many industries. With Shopify's tools and ecosystem, entrepreneurs can overcome many technical barriers and focus on building their unique value proposition.
Overcoming barriers to entry
Successful entrepreneurs find creative ways to navigate around barriers to entry. Here are strategies that have worked for real businesses:
Niche specialization
Rather than competing directly with established players, find underserved market segments. You can follow the example of Beardbrand, a men's grooming brand that focused specifically on beard care products before expanding to other grooming products.
Innovative business models
Disrupt traditional approaches with new ways of delivering value. For instance, Bombas, a sock company, has revolutionized the customer feedback loop by investing in R&D (research and development) to fix sock design problems soon after they are identified. So far, it has created stay-up technology, a honeycomb arch support system, a blister tab, and a seamless toe, for added comfort.
Strategic partnerships
Leverage relationships with established players. Many successful direct-to-consumer (DTC) brands partner with larger retailers to expand their reach while maintaining their direct customer relationships. Common in the packaged goods and beauty categories, you’ll see brands like Nguyen Coffee and Pho’nomenal Foods, Ortega Beauty and Tower 28 on the shelves of Walmart, Costco, Nordstrom, and Sephora while still selling and cultivating their communities with DTC.
Technology leverage
Use digital tools to operate more efficiently than incumbents. Shopify merchants can access enterprise-level ecommerce capabilities without massive IT investments, leveling the playing field with larger competitors.
Community building
Develop passionate customer advocates who spread the word about your brand. Glossier built a devoted following through community engagement before expanding their product line.
Strong marketing campaigns
Often, established businesses spend a lot of money on marketing and advertising to differentiate their products, which builds brand recognition and customer loyalty, making new entrants harder to get customers. For instance, in many regions, Coca-Cola is synonymous with soft drinks, so newcomers might have a hard time getting into the market. Brands like De La Calle Tepache need to lean into their unique selling proposition since they can’t beat the marketing budget of established businesses.
Reducing cost per unit
With economies of scale, larger companies can offer lower prices or better margins by reducing their cost per unit. With its huge distribution network and sales volume, Amazon gets lower prices and faster delivery than smaller retailers.
Being innovative
New entrants can disrupt established markets by offering innovative products, services, or business models. Tesla challenged the dominant position of traditional gasoline-powered car manufacturers when it entered the automobile market with electric vehicles.
Overcoming policy and regulation
Antitrust laws and fair competition regulations are crucial in preventing monopolies and ensuring a level playing field. The European Union's fines against Google for abusing its market dominance is a reminder of the importance of regulatory oversight in maintaining competitive markets.
Making an impact on the market
By bypassing traditional channels, Warby Parker revolutionized the eyewear industry through offering designer-quality eyewear at lower prices. Its direct-to-consumer model, competitive pricing, and innovative customer engagement strategies have forced traditional eyewear retailers and brands to rethink their strategies.
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Barriers to entry FAQ
What is a barrier to entry?
A barrier to entry refers to any obstacle or difficulty that prevents new competitors from easily entering an industry or area of business. There are lots of barriers to entry, such as high startup costs, strict regulations, strong brand loyalty for existing companies, and access to raw materials and technology.
What are the 3 barriers to entry?
Barriers to entry generally fall under three categories: artificial, natural, and government. Natural refers to structural barriers to entry, artificial refers to strategic barriers to entry, and government refers to regulation and legal requirements established by governments.
What is a barrier used to prevent entry?
- Tax benefits given to established companies in a certain industry
- Price reduction by established companies to prevent potential entrants from competing
- Patent protection
- Licenses required by the government to enter a specific market
- Brand loyalty