Barriers to entry
Oligopolies and monopolies frequently maintain their position of dominance in a market might because it is too costly or difficult for potential rivals to enter the market. These difficulties are called barriers to entry. They can be erected deliberately by the incumbent(s), or they can exploit barriers that naturally exist in the market.
Natural entry barriers include:
Economies of large scale production.
If a market has significant economies of scale which have already been exploited by the incumbents, new entrants are deterred.
Ownership or control of a key scarce resource.
Owning scarce resources, which other firms could use, creates a considerable barrier to entry, such as an airline controlling access to an airport.
High set-up costs.
High set-up costs deter initial market entry. Many of these costs are sunk costs. Sunk costs are those that cannot be recovered when a firm leaves a market, and include marketing and advertising costs and other fixed costs.
High R&D costs
When firms spend money on research and development (R & D), it is often a signal to potential entrants that they have large financial reserves. In order to compete, new entrants will have to match, or exceed, this level of spending in order to compete in the future. This deters entry and is widely found in oligopolistic markets such as pharmaceuticals and the chemical industry.
Artificial barriers include:
A firm may deliberately lower price to try to force rivals out of the market.
Limit pricing means the incumbent firm sets a low price, and a high output, so than entrants cannot make a profit at that price. This is best achieved by selling at a price just below the average total costs (ATC) of potential entrants. This signals to potential entrants that profits are impossible to make. The incumbent is exploiting its superior knowledge of the market, and production costs, for its own advantage.
This involves taking over a potential rival by purchasing sufficient shares to gain a controlling interest, or by a complete buy-out. As with other deliberate barriers, regulators, like the Competition Commission, may prevent this as it would reduce competition.
Advertising is another sunk cost - the more that is spent by incumbent firms the greater the deterrent to new entrants.
A strong brand
This creates loyalty, ‘locks in’ existing customers and deters entry.
Exclusive contracts, patents and licences
Contracts, patents and licences make entry difficult as they protect existing firms who have won the contract, or who own the license or hold the patent. For example, contracts between specific suppliers and retailers can exclude other retailers from entering the market.
This can ‘tie up’ the supply chain and make life difficult for potential entrants, such as a manufacturer having its own retail outlets, such as a brewer owning its own pubs.