How competitive is your industry? As you look to keep your business growing, you’ll likely be aware of your competitors and what they bring to the table. After all, you’re trying to attract the same type of customers. At the same time, you have to be on the lookout for new companies looking to enter your industry. But how do you measure the competitiveness of your market? Many experts do this through an industrial analysis framework called Porter’s Five Forces. Through this framework, you can get a more accurate picture of the rivalry among existing competitors and what the potential threat of new entrants might be. You can also use it to see which industry will give you the best chance of success for your company.
Read on to learn about Porter’s Five Forces, what the threat of new entrants is, some of the common barriers to entry, and how to compare these different factors.
Porter’s Five Forces
First developed by Harvard University professor Michael Porter, Porter’s Five Forces present a framework that helps company leaders analyze the level of competition within an industry. The threat of new entrants is one of these forces, but the others also play significant roles in determining how competitive specific industries can be. These other forces include the bargaining power of suppliers, bargaining power of buyers, the threat of substitutes or threat of substitute products, and competitive rivalry.
What is the Threat of New Entrants?
As part of Porter’s Five Forces, the threat of new entrants refers to how threatening a new competitor might be to companies that already have a place in their respective industries. That includes how easy it is for new companies to enter the industry in the first place. If the threat is high for an industry, it likely means new competitors show up frequently and gain traction without much difficulty. If the threat is low, industries will likely see few new competitors. Even when new companies do enter the market, they will find success harder to achieve.
Barriers to Entry
When analyzing the threat of new entrants, you must look at the barriers to entry for an industry. These barriers represent the obstacles people at a new company must overcome to get their business off the ground. The following are the most common barriers to entry new competitors face.
1. Brand Loyalty
Existing companies may have brand loyalty among customers. In other words, their customers have a sense of loyalty that ties them to a particular company that makes them want to buy their product or service. Brand loyalty can be a driving force for customer decisions. New entrants in an industry that already features high brand loyalty may find it challenging to get customers in that field to pay attention to them. Take the video game console market, for example. The leading players in that market are Nintendo, Sony PlayStation, and Microsoft Xbox. Each brand has its devoted and passionate fans, making it difficult for new entrants to gain traction. The list of failed video game consoles is long, even though it features names known for their success in other industries, like Philips and Nokia.
2. Technology Access
To compete in some industries, companies need to have access to some of the latest technology. This access represents another barrier to entry since not just any company can use breakthrough technologies to compete. Take the telecommunications industry as an example. To compete there, you would need the same type of technology businesses like Verizon and AT&T have, requiring substantial investments that would eat into profits. As such, it’s challenging to get a new company up and running in that environment.
3. Government Policies
Another barrier to entry is the government policies that have an impact on specific industries. If a company has to go through piles of red tape, it is much more challenging to get started. Many sectors have numerous rules and regulations they have to handle, which impose obstacles on new companies. The pharmaceutical industry is one such area featuring heavy regulations and legal standards. New competitors may shy away from the industry altogether with so much to contend with regarding legal requirements.
4. Economies of Scale
Economies of scale represent significant cost advantages of organizations that have already been established. The large size of companies with economies of scale gives them an edge since it costs less to make a product or offer a service. New companies don’t have that advantage and need to start from scratch. An example of economies of scale comes from parcel companies like FedEx and DHL. Since they already provide a vast network of delivery services, their costs are relatively low. A new competitor would have much higher costs to start out, which is why you see so few new companies in that industry and a decreased threat of new entrants.
5. Distribution Channels
In addition to economies of scale, another barrier to entry includes access to distribution channels and suppliers. Some companies already have a distribution network they use regularly. Some also have exclusive access to suppliers. These aspects make it difficult for new companies to get started. Think of the advantages major retail stores like Walmart have when it comes to supply and distribution. That network took decades to build up, giving them an edge over the competition. For newcomers to the retail industry, they must work from a less advantageous position.
6. Initial Capital
Another barrier to entry is the initial capital needed to start a business. In some industries, including those with high profit potential, the capital company owners need can be enormous. While most small businesses have startup costs of 25,000 dollars or less, the initial capital for some areas can be as high as three million dollars. With such a number, new companies rarely enter the market. As a result, the threat of new entrants is low. One field where this is the case would be the oil and gas industry, which features high expenses for equipment and technology to get the ball rolling.
You can calculate your startup costs by going to this handy guide from the U.S. Small Business Administration.
7. Switching Costs
Another obstacle new entrants face is called switching costs. These costs are what consumers pay when changing the brand they usually use. Areas with high switching costs will feature a low threat of new entrants because consumers will be less likely to change their buying habits by choosing a new brand. Switching costs come in forms outside the monetary kind, such as the amount of effort needed or the psychological costs. An example of a low switching cost would be going from one soft drink to a different one. A high switching cost would be a brand of software a company uses since changing would require purchasing new software, integrating it with work processes, training workers how to use it, and more.
Threat of New Entrants Analysis
With the barriers to entry in mind, you can move on to analyzing them to figure out how high or low the threat of new entrants is for your industry. For example, if your industry has low brand loyalty and few government regulations, the threat of new entrants will likely be relatively low, and you may be able to carve out some market share. This environment would lead to more chances for business growth. On the other hand, if your industry requires significant capital investment and provides only restricted access to suppliers, the threat of new entrants will be high.
Success is Not Guaranteed
Just because an industry has low barriers to entry does not mean success is a guarantee. Look at the food industry and how many restaurants open every year in your community only to close after a short period of time. It takes hard work, a clear vision, and inspiring leadership to make a business work. At the same time, if you’re able to overcome the challenging barriers to entry for an industry with a low threat of new entrants, you may find a ripe opportunity to grow your company. Even in that situation, you’ll need to show charismatic leadership and a strong work ethic to rise above the competition and find success. However, knowing about the threat of new entrants will help you prepare for the challenges that lie ahead.