Ease of entry: a step beyond entry barriers.

Kunkel, Scott W. ; Hofer, Charles W.

ABSTRACT

The concept of entry barriers has been passed from discipline to discipline--from Industrial Organization Economics to Strategic Management to Entrepreneurship. Recent attempts to examine the impact that entry barriers have on new venture performance (i.e., Yip, 1982, and McDougall, 1987), have found that the direct impact of entry barriers on new venture performance is difficult to gauge when entry barriers are measured in traditional ways. This paper suggests that the traditional view of entry barriers is incomplete and proposes a new construct, called "ease of entry," (1) which includes, but is not limited to entry barriers.

INTRODUCTION

Bain (1956) introduced the concept of "entry barriers" to the literature of industrial organization economics (IO). Hofer (1975) brought the concept of entry barriers to the field of strategic management. Porter (1980) expanded the concept, breaking entry barriers down into two classes: entry barriers created as a result of the structural characteristics of the industry ("structural entry barriers") and entry barriers created as a result of the threat of retaliation by incumbents ("retaliation entry barriers").

Yip (1982) expanded the understanding of entry barriers by applying the strategy paradigm to prior IO theories of entry and entry barriers. Yip expanded entry barrier theory to include entry through acquisition, rather than limiting entry to new legal entities, as had previously been done in IO theory. Yip also introduced the term "entry gateways" to represent situations in which an entrant may not face barriers to entry but, instead, may actually be in an advantageous position vis-a-vis incumbents in the industry.

McDougall (1987) attempted to measure the impact that entry barriers have on new venture performance. In testing this relationship, McDougall operationalized "entry barriers" as a composite of five variables. Accepting IO theory, McDougall included as the five most significant sub-variables of entry barriers:

1. economies of scale (using minimum efficient plant size as a
surrogate for economies of scale)

2. product differentiation (using advertising-to-sales ratio as a
surrogate for product differentiation)

3. industry concentration, (using the four-firm concentration
ratio)

4. capital intensity, (using the assets/value-added ratio as a
surrogate for capital intensity)

5. rate of growth of total market demand in the industry.

McDougall (1987) calculated a composite height of entry barriers score for each of nine four-digit Standard Industrial (SIC) codes, then compared this composite height of entry barriers score with the performance of the firms in that SIC code. McDougall found some support for the proposition that entry barriers affect profitability of firms within industries, but no support for the proposition that entry barriers affect market share or market share growth, measures of operational performance.

McDougall's (1987) five sub-variables are based on those which IO theorists have most often suggested as the most important sub-variables in entry barriers. This paper makes three suggestions:

1. One of the five sub-variables which IO theory suggests as making
up entry barriers (industry concentration) should not be included
in entry barriers at all because it influences entry both
positively and negatively.

2. There is a set of sub-variables called "entry gateways" which
should be included along with entry barriers in the analysis of
entry.

3. The inclusion of entry gateways along with entry barriers in the
analysis of entry into industries suggests a new construct, called
"ease of entry."

EXCLUSION OF INDUSTRY CONCENTRATION FROM ENTRY BARRIERS

IO researchers have consistently hypothesized that "industry concentration" is an entry barrier. McDougall (1987) included concentration ratio in the calculation of entry barriers, thereby implicitly accepting the IO assumption that concentrated industries are more difficult to enter than less concentrated industries.

Studies by Biggadike (1976, 1979) and by Hobson and Morrison (1983), on the other hand, indicate that new venture entry is more successful when the entered industry has a dominant competitor, one with greater than 49% market share, than when the largest competitor has less than a 25% share. This indicates that a high concentration ratio, rather than being a barrier to entry, may be a factor which makes entry easier.

Hofer and Sandberg (1987) explain why this phenomenon may be exactly the opposite of what had been earlier hypothesized in IO literature. As they explain, if the few industry leaders have a very large share of the market, then each of the other competitors has a very small share of the market.

The key point here is that new entrants almost never compete head-to-head with the industry leader. Rather, they typically seek entry into smaller segments (or niches) of the market where they face either no competition or competition from the smaller competitors in the industry (p. 13).

Since new entrants usually compete with the smaller competitors in the industry, when the industry leaders are relatively stronger, the smaller competitors are relatively weaker and more vulnerable to attack by a new venture.

Peters (1987) offers another possible explanation as to why concentrated industries may be easier to enter than less concentrated industries. Peters suggests that large firms are often myopic. In industries populated by a few large firms, each firm frequently fights for its share of the "mass markets." In making their products as generic as possible, in order to appeal to the largest number of potential customers as possible, these firms often leave several smaller market segments unserved or under-served. These unserved or under-served market segments offer opportunity for smaller new ventures which are able to serve these smaller market segments profitably.

It appears, then, that measuring "industry concentration" is measuring the wrong variable. The fact that an industry is highly concentrated may act simultaneously to make entry more difficult and to make entry easier. Whether a few firms have the lion's share of the market, therefore, is not directly relevant to a potential new entrant. What is relevant, however, is whether there are market segments which are unserved or under-served.

As an illustration, assume that one firm holds virtually 100% of a market (monopoly, the ultimate in "industry concentration"). Assume, however, that it is serving several distinct market segments, each of which has significantly different needs. It is serving them with a single generic product which serves the purpose for all market segments adequately, but does not serve any one segment's needs completely. This situation would be an open invitation to a new venture to enter the industry serving one or more market segments with products which are more specifically tailored to the particular needs of the market segments. This is the situation which prevailed when General Motors took the U.S. automobile market from Henry Ford in the 1930s by offering several models of cars, each designed to appeal more specifically to a single market segment than the Ford Model T, which was designed to be the car for everyone. The high "industry concentration" in this case is not an entry barrier but, rather, an entry gateway.

On the other hand, assume that several firms, each with a small market share (low "industry concentration"), serve a market which is basically homogeneous (an unlikely, yet possible situation). In this market, the needs of every consumer are basically the same. Each firm provides a product which fulfills the needs of every consumer and seen as excellent substitutes for one another. In this case, it would be difficult for a new venture to enter the industry since there are no market segments which are unserved or under-served. In spite of low "industry concentration," the entry barrier is high. Because of these theoretical weaknesses in the industry concentration construct, as well as the empirical contradictions (Biggadike, 1976, 1979; Hobson & Morrison, 1983, versus IO literature), this paper suggests that "industry concentration" should not be considered to be only an entry barrier.

ENTRY GATEWAYS

Yip (1982), in his analysis of entry barriers, suggested that there are certain situations in which mitigating circumstances may neutralize entry barriers, even to the extent of placing a new entrant in an advantageous position vis-a-vis incumbents in the industry. These situations Yip called "entry gateways." Yip, unfortunately, did not expound on the concept of entry gateways other than to suggest that one such entry gateway is "industry disequilibrium." According to Yip, "industry disequilibrium" can be caused by rapid growth of the industry, recent technological change, high capacity utilization (shortage of supply), and the exit of incumbents from the industry (p. 39).

Yip's definition of entry gateways, however, suggests that sometimes entry gateways may be created, not as a result of any structural condition within the industry, but due to the unique set of skills and resources which are in the possession of the potential entrant. It appears, therefore, that there are two kinds of entry gateways: entry gateways which are a result of the structural characteristics of the industry ("structural entry gateways") and entry gateways created by the unique set of skills, resources, and contacts possessed by the potential entrant ("resource entry gateways"). This recognition of the impact which entry gateways have on entry barriers suggests a broader construct, "ease of entry," which includes entry barriers as affected and mitigated by entry gateways.

EASE OF ENTRY

Kunkel (1991) surveyed twenty-one works in the fields of Industrial Organization Economics, Strategic Management, and New Venture Performance and identified fifty-eight industry structural variables which have been suggested in those twenty-one works as being significant contributors to the structure of an industry, thus having an impact on business unit performance. Thirty-one of the fifty-eight industry structural variables so identified influence industry structure primarily by their effect on entry into the industry. Figure 1 classifies these variables based on whether their effect would be as an entry barrier or an entry gateway, then sub-categorizes the variables into "structural entry barriers" ("cost based" and "non-cost based") and "retaliation entry barriers," and into "structural entry gateways" and "resource entry gateways."

[FIGURE 1 OMITTED]

"Structural entry barriers" are those structural characteristics of an industry which make entry more difficult. The effect of these "structural entry barriers" is cumulative; that is, an industry which exhibits several of the characteristics which create "structural entry barriers" is more difficult to enter than an industry which exhibits only a few of these characteristics. However, one very high structural entry barrier may be more effective at preventing the entry of a specific potential entrant than several moderately high structural barriers.

"Retaliation entry barriers" are those characteristics of an industry which increase the likelihood of strong and effective retaliation by incumbents. The existence of these characteristics does not guarantee that retaliation will be strong and effective, or that it will occur at all; it merely increases the probability that retaliation will occur. A potential new entrant will increase its estimate of the risk of prolonged and unprofitable warfare when retaliation is a strong likelihood, thereby decreasing the expected profits to be gained by entering the industry.

An application of the "time value of money" concept in financial theory helps to explain why this decrease in expected profits occurs. The high probability of retaliation results in a decrease in the discounted present value of the future income to be derived from entering the industry. This decrease in the discounted present value of the future income streams is a result of two factors:

1) estimates of the expected future incomes decrease

2) the riskiness of the estimates of future incomes increases,
thereby requiring a higher discounting interest rate.

This discounting process has the effect of decreasing the desirability of entering an industry where there is a strong probability of retaliation, compared to an industry where there is little likelihood of retaliation. Thus, the threat of retaliation acts as an entry barrier, and the greater the perceived likelihood of retaliation and the greater the perceived likely strength of that retaliation, the greater the discounting of future income flows and the lower the expected value of entry into the industry.

"Structural entry gateways" are those characteristics of an industry which create influences which mitigate the severity of structural entry barriers or decrease the likelihood of effective retaliation. Structural entry gateways are also cumulative, i.e., an industry which exhibits several structural entry gateways is easier to enter than an industry which exhibits only one, but one large opening as a result of a structural entry gateway may make more of a difference to a particular prospective entrant than several small structural entry gateways. These entry gateways are created as a result of the characteristics of the industry and do not rely on special skills or resources of the entering firm.

"Resource entry gateways," on the other hand, are particular skills, resources, or contacts which a potential new entrant may possess which act as a mitigating influence on the structural and retaliation entry barriers the potential new entrant faces in the industry it hopes to enter.

Based on the recognition that entry gateways act to mitigate the effect of entry barriers, a more complete construct seems to be "ease of entry," which is a function of entry barriers as mitigated and influenced by entry gateways. "Structural ease of entry" includes those factors which are identifiable as part of the industry structure, including "structural entry barriers," "retaliation entry barriers," and "structural entry gateways."

A major shortcoming of the "entry barriers" construct as developed by Bain (1956) and expanded by Porter (1980) is that each of the sub-variables (for example, "gross margins") is categorized in only two classes, high and low. Low gross margins are viewed as an entry barrier and high gross margins are viewed as the absence of the entry barrier. A much richer construct becomes apparent, however, when gross margins are categorized into three classes, high, average, and low.

Exceptionally low gross margins create an entry barrier, as hypothesized by Porter (1980). Average gross margins imply the absence of this barrier. Exceptionally high gross margins, however, create an entry gateway, making it easier for a new venture to enter the industry since it is so easy to recover entry costs with the exceptionally high gross margins. Many potential investors, entrepreneurs, and corporations are scanning the environment to discover opportunities. Gross margins which are much higher than average invite new entrants.

Many of the sub-variables in Figure 1 appear in more than one list. For example, although industry concentration should not be considered an entry barrier without considering its impact as an entry gateway, Figure 1 includes industry concentration in three lists. First, industry concentration can be considered a structural entry barrier to the extent that concentration encourages powerful competitors to defend their turf. Industry concentration also presents a potential retaliation barrier, since a small number of competitors, at least theoretically, can more easily act in concert to prevent entry and/or retaliate against new entrants. Industry concentration is also an entry gateway, however, because concentrated industries frequently have smaller, weaker competitors and/or unserved/under-served market niches.

Other sub-variables appear in more than one list, with a high (or low) value acting as an entry barrier and the opposite value acting as an entry gateway. For instance, high entry costs (including high capital intensity, high advertising intensity, high selling intensity, high R&D intensity, large marginal plant size, etc.) all act as cost based structural entry barriers. Extremely low entry costs (including low capital intensity, low advertising intensity, low selling intensity, low R&D intensity, small marginal plant size, etc.) act as an entry gateway, making industries with such characteristics easier to enter and making it more difficult for incumbents to build barriers to deter entry.

The construct presented in Figure 1 is involved and includes a large number of sub-variables. This model can be simplified by grouping the sub-variables into sets, as shown in Table 1.

As can be seen in Table 1, each of the five major impacts on entry (existence of opportunity for entry, economics of entry, potential effectiveness of entry, likelihood of retaliation, and potential effectiveness of retaliation) is influenced by groups of sub-variables.

First, the "non-cost based structural entry barriers" as offset by the "structural entry gateways" determine the "existence of the opportunity for entry." Second, the "cost-based entry barriers" combined with the "gross margins" available in the industry determine the "economics of entry." Third, since control of the resources for entry is essential for successful and effective entry, the "resource-based entry gateways" determine the "potential effectiveness of entry." Fourth, the "retaliation entry barriers" determine the "likelihood of retaliation." Fifth, the "control of resources by incumbents" determines the "potential effectiveness of the retaliation."

A DESCRIPTIVE METAPHOR

In order to capture the effect that "entry barriers" and "entry gateways" have on "ease of entry," a metaphor is useful (2). A new entrant into an industry can be likened to a burglar attempting to gain entry to a mansion. Different barriers are effective against different potential burglars because different burglars have different talents, skills, and resources for overcoming different barriers. For instance, a cat burglar may find walls to be of little or no deterrence, whereas the electronics expert is not foiled by a security system.

The best defense of the mansion is attained by having several types of barriers, high walls, locked doors, security systems, etc. Different barriers will provide different deterrent value to different burglars, but if they can be combined, they can provide a formidable obstacle for any burglar.

The cat burglar who discovers that the mansion has a security system may retreat. The electronics expert who finds that the only unbarred window is on the third floor may choose another target. Whether a specific barrier is effective against a specific potential entrant is a function of the barrier as it matches the particular skills and resources of the potential entrant. Nonetheless, the more barriers there are, the lower the likelihood that any potential entrant will have the skills and resources necessary to overcome them all.

Following the logic of the mansion metaphor, it may be that no combination of locks, doors, walls, and security systems can keep a well equipped and determined professional burglar from entering the mansion. This is not to say, however, that a well secured mansion is as vulnerable to invasion as one which is totally unprotected and open. The walls and door-locks keep the amateur burglar and the casual passer-by from entering, as well as making it more difficult for even the professional burglar to get in, thereby decreasing the probability that anyone will successfully breach the security of the mansion.

From the point of view of the incumbents in the industry, the existence of higher entry barriers increases the profitability of the industry as a whole, as Bain (1956) and other IO researchers suggest. Sandberg (1984, 1986) found that raising the height of entry barriers after the new venture has entered the industry (thereby becoming an incumbent in the industry) significantly increases the performance of the venture.

Orr (1974) established that entry barriers decrease the occurrence of entry, thereby increasing the profitability of the incumbents in an industry with high entry barriers over that of firms in industries with low entry barriers. Orr only classified entry barriers as high or low, however. If the concept of entry gateways mitigating the influence of entry barriers has validity, it would seem that moderate entry barriers would eliminate the majority of potential entrants, whereas even a high level of entry barriers would not totally eliminate the possibility of an individual potential entrant being able to overcome the barriers to entry.

If this were the case, raising entry barriers from low to moderate would have a greater impact on deterring entry than raising entry barriers from moderate to high. This was exactly the finding in one study by Mann (cited in Caves, 1987). Although Mann was at a loss to explain his observations, they are directly in line with what would be expected according to the above discussion of the effect of entry gateways on entry barriers.

THE NEXT STEPS

This paper has made three major points. First, it has recommended that at least one of the five sub-variables which IO theory suggests as making up entry barriers (industry concentration) should not be considered an entry barrier at all, since it has the simultaneous effects of both discouraging and encouraging entry. By showing the mixed contributions which industry concentration makes, this paper has argued that industry concentration, contrary to IO theory, is not strictly an entry barrier.

Second, this paper developed the concept of entry gateways, as introduced by Yip (1982), and has shown that entry gateways should be included along with entry barriers in any analysis of entry into industries. The development of the concept of entry gateways, however, indicates the need for a broader construct than entry barriers when analyzing entry.

Third, therefore, this paper developed and presented the conceptual construct called "ease of entry" to better represent the factors influencing entry. Moving from the general model of ease of entry which included over 30 sub-variables, this paper then simplified the construct to include five influences on entry:

1. the existence of the opportunity for entry

2. the economics of entry

3. the potential effectiveness of entry

4. the likelihood of retaliation by incumbents

5. the potential effectiveness of retaliation by incumbents

This paper has suggested a broadening of existing theory on entry barriers. Nevertheless, much work remains to be done before the theory of ease of entry is fully developed. Among the more important steps are the following:

1. Methods need to be devised to operationalize the five groups of
sub-variables.

2. A data base needs to be built which will provide information on a
significant number of these sub-variables on several to many
industries.

3. Finally, tests of the validity of the new construct need to be
conducted so that the theory may be tested and expanded.

Because new venture entry has been shown to be such a major contributor to growth in employment and the health of the economy as a whole (Kunkel, 1991), it is crucial that new venture researchers develop a better understanding of the factors which influence entry into industries and contribute to the success and failure of new ventures. Only by better understanding the barriers to entry and the factors which influence ventures' ability to overcome such barriers can the high costs of new venture failure be reduced.

REFERENCES

Bain, J. S. (1956). Barriers to new competition. Cambridge: Harvard University Press.

Biggadike, E. R. (1976). Entry, strategy, and performance. (Doctoral Dissertation, Harvard University). Dissertation Abstracts International. 37, 3006A.

Biggadike, E. (1979). Corporate diversification: Entry, strategy, and performance. Cambridge: Harvard University Press.

Caves, R. E. (1987). American industry: Structure, conduct, performance (6th ed.). Englewood Cliffs, NJ: Prentice-Hall.

Hobson, E. & Morrison, R. (1983). How do corporate start-up ventures fare? Frontiers in entrepreneurship research, 390-410.

Hofer, C. (1975). Toward a Contingency Theory of Business Strategy. Academy of Management Journal, 18, 784-810.

Hofer, C. & Sandberg, W. (1987). Improving new venture performance: Some guidelines for success. American Journal of Small Business, 12(1), 11-25.

Kunkel, S. (1991). The impact of strategy and industry structure on new venture performance. (Doctoral Dissertation, University of Georgia).

McDougall, P. (1987). An analysis of strategy, entry barriers, and origin as factors explaining new venture performance. (Doctoral dissertation, University of South Carolina). Dissertation Abstracts International, 48, 980A.

Orr, D. (1974). The determinants of entry: A study of the Canadian manufacturing industries. Review of Economics and Statistics, 56, 58-66.

Ortony, A. (1975). Why metaphors are necessary and not just nice. Educational Theory, 25(1), 45-53.

Peters, T. (1987). Thriving on chaos: Handbook for a management revolution. New York: Harper & Row.

Porter, M. E. (1980). Competitive strategy. New York: The Free Press.

Sandberg, W. R. (1984). The determinants of new venture performance: Strategy, industry structure and entrepreneur. (Doctoral dissertation, University of Georgia). Dissertation Abstracts International, 46, 464A.

Sandberg, W. (1986). New venture performance: The role of strategy and industry structure. Lexington: Lexington Books.

Weick, K. E. (1979). The social psychology of organizing, Reading, MA: Addison-Wesley.

Yip, G. S. (1982). Barriers to entry: A corporate strategy perspective. Lexington, MA: Lexington Books.

END NOTES

(1) The Ease of Entry concept can be viewed either from the perspective of the new venture attempting to enter the industry or from the perspective of the incumbents in the industry attempting to keep new ventures out. Either positive or negative terms may be used. For example, from the point of view of the incumbents in the industry, positive terms for this concept include "security against entry" and "entry defensibility" and negative terms include "entry vulnerability" and "entry susceptibility." From the point of view of the new venture, positive terms include "ease of entry" and "entry opportunity," and negative terms include "entry difficulty," and "obstacles to entry." Since the perspective of this paper is new ventures, the term "ease of entry" is used.

(2) Ortony (1975) argues that when trying to understand complex phenomena, metaphors are not just nice, they are necessary. Weick (1979) explains that although metaphors are only partially complete representations of reality, as are models, metaphors provide three benefits: (1) metaphors provide a compact version of an event without the need to spell out all the details; (2) they enable people to predicate characteristics which are unnameable; and (3) they are closer to perceived experience, more vivid emotionally, sensorially, and cognitively. Therefore, like models, metaphors are tools for enhancing communication.

Scott W. Kunkel, University of San Diego Charles W. Hofer, University of Georgia

TABLE 1: Ease of Entry Sub-Variables

Non-cost Based Structural Entry Determine Existence of
 Barriers and Structural Opportunity for
 Entry Gateways Entry
Cost Based Structural Entry Determine Economics of Entry
 Barriers
Resource Based Entry Gateways Determine Potential Effectiveness
 (Control of Resources of Entry
 by Entrant)
Retaliation Entry Barriers Determine Likelihood of
 Retaliation
Control of Resources by Determine Potential Effectiveness
 Incumbents of Retaliation