12-Evolution of Industries and BTE

7/27/2019 12-Evolution of Industries and BTE

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Evolution of

Industries and

Barriers to Entry 12THE RESULTS OF COMPETITION: WINNERS AND LOSERS

As firms compete with one another, eventually a firm or a set of firms gains a

competitive advantage. Perhaps the firms gaining this advantage have greater

skill, or were more ruthless, or were simply lucky.

As one group of firms gain an advantage, the rest of the firm in an industry

are placed at a competitive disadvantage. One consequence of a temporary

disadvantage is, among other things, a smaller proportion of industry sales and

lower profits for the disadvantaged firms. If sales and profits fall to low levels

for long enough, the firms at a competitive disadvantage might be forced to

leave the industry.

Perhaps because of falling revenue, some firms are not able to pay theircreditors these firms might be forced into bankruptcy. Or, perhaps the owners

of the firm see the writing on the wall and fear they will never be able to earn

high enough profits in the industry and they voluntarily leave the industry.

Every year countless thousands of businesses shut their doors as they fail to

make acceptable profit for the owners.

But, as the losing firms exit the industry the existing firmsthe winners

expand and take over the sales of the firms that have exited. Often, the

winnersindividually and collectivelyfind that their profits are greater now

that some of their competitors have been forced to leave the industry.

In short, competition creates winners and losers. The winners expand thatgrab a larger share of the market and often benefit from higher profits. The


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128 Evolution of Industries and Barriers to Entry

losers lose market share, earn lower profits and, perhaps eventually, are forced

to leave the industry.

Yet nothing is given. A firm that appears to be on the way out might

suddenly find some change in the produce that consumers really like or might

sudden introduce a product much preferred by consumers. And, firms that have

been successful for year-after-year by reinvesting profits might find some

innovation they have introduced fails and consumers stop buying from the

previously successful firm. In competition, all bets are off.

Yet, at some point, firms will fall far enough behind the others in the

industry. These firms might leave the industry either by choice or they might do

so because they are forced to declare bankruptcy.

Alternatively, some firms that were unable to win in competition might seek

to become small niche producers: specializing in the sale of that part of what

the industry produces that is much lower profit than sold by the winning firms

or which is sold in only a small amount and bigger firms are not interesting in

producing that particular item. Not every firm losing the main battle within the

industry is able to remake themselves as a niche producer: most firms that lose

the main competition within the industry are forced to exit the industry.

Once the losers have left, or found small and often low-profit niches within

the industry, the firms that have won in competition now do battle among

themselves. The new batch of winners soon becomes split into winners and new

losers.

THE INDUSTRY AFTER A PERIOD OF COMPETITION

After a long period of competition, an industry most likely has experienced a

major decline in the number of competitors as the losers exit. The winners now

battle among themselves and some past winners now become losers and they

too exit the industry. Larger firms come to dominate the industry.

However, a handful or perhaps a dozen or two of smaller firms might

remain within the industry. These fringe firms might produce a variant of the

product that is much less profitable than the bulk of what is sold in the

industry. The large firms have not interest in producing these low-profit variant

of the product and, so, they dont aim their competitive aggression at the small

fringe firms.

Collectively, though, these fringe producers account for only a relatively

small amount of the industries product.


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Evolution of Industries and Barriers to Entry 129

The process involved in competition is illustrated in Figure 0-1. Competition

transforms an industry from one in which a large number of small firms

dominate the industry to one in which a small number of large firms dominate

the industry. A few small firms might survive as niche producers that earn a

level of profits too low to interest the main winners in the industry.

Figure 0-1

Car industry1910

Car industry1940

Car industry1960

COMPETITION AND MERGERS

Competition leads to fewer and larger firms as the winners expand and take

sales away from loser firms. Competitionor the desire to win in

competitioncan also lead firms to merge with one another. As will be

discussed below, larger firms can have advantages over smaller firms. These

advantages can lead to higher profits and greater competitive abilities.

Firms, therefore, sometimes combine forces by merging. Part of the reduce

firms in an industry and part of the increased size of these firms comes about

simply because firms have merged in order to enhance their profitability.


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THE ENTRY OF NEW COMPETITORS IN AN INDUSTRY

But, before an industry becomes dominated by a relative small number of small

firms a process can be set into motion that counteracts the development of large

dominant firms.

In capitalism, businesses want profits. Moreover, they want high profits.

When existing businesses are looking to increase their profits by expending

into new industries and when new businesses are looking for a good industry to

enter, one of their goals is to find an industry in which the profits are high.

High profit industries attract a lot of attention from those outside the

industry. Low profit industries, on the other hand, often attract little attention.

As competition within an industry occurs, winners expand and winners

individually and collectivelyearn higher profits. In turn, these higher profits

attract attention from outsider.

The new winners find, much to their disappointment, that their success in

competition (in particular, the resulting higher profits) leads outsiders to

consider entering the industry. If these outsiders do enter the industry,

competition heats up to a higher level and, most often, profits are again pushed

down for all in the industry.

This process is illustrated in Figure 0-2 below. Competition does lead to a

reduction in the number of competitors and some firms do get larger. But the

higher profits of these firms attract the attention of entrepreneurs and firms

outside the industry. They enter the industry hoping to earn higher profits. But

by entering the industryand increasing competitionthey drive down profits.

Figure 0-2

Machine tool

Industry

Construction

industry

Car industry


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What the winners in an industry want is to find themselves a way to be not

subjected to the continual appearance of new competitors. In such an industry,

a high level of profits can last for a long time.

BARRIERS TO ENTRY

Firms want to earn high profits. Firms that have become winners in competition

can find, however, that the high profits they achieve disappear as new firms

enter the industry. As new firms enter the industry, competition increases and

profits fall. Worse for the firms which once stood preeminent in the industry,

one or more of the new firms entering the industry might talented or lucky

enough to drive out of business the once preeminent firms in the industry.

Not surprisingly, firms that have achieved profitable positions within an

industry would like to keep new firms from entering the industry. In order

words, they would like to construct barriers to entry for their industry. If

they can successfully construct barriers to entry then firms within the industry

can benefit from continued high profits. Alternatively, if firms are lucky to find

themselves with barriers to entry (that were not intentionally constructed) they

can also benefit from good profits for a lengthy period.

BARRIERS TO ENTRY DEFINED

Some industries are the site of relentless competition. Winners win and push out

loser firms. But new firms appear to take the place of the exiting firms and

competition never wanes. One of the new competitors might push out of

business one of the firms in the industry that had previously been a winner.

Other industries are able to find some release from continual relentless

competition. Still other industries find they are successful in significantly

reducing or, even, eliminating competition.

It is the dream of every entrepreneur to find her/himself in the latter type of

industry.

Why do some industries face relentless competition? Why do others face

only a medium level of competition? Why do a few industries face very little

competition?

The key is often the absence or existence of barriers to entry.


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Barriers to entry (or, BTE) are anythingthat hinders the movement of firms

into an industry. That is, BTE reduce or eliminate the entry of new businesses

into an industry.

Sometimes BTE can be almost insurmountable: no new firms can enter an

industry. Other times BTE can slow down the entry of new firms: new firms

appear but only slow. Very low BTE, however, means that new firms can enter

the industry relatively rapidly.

SELECTED BARRIERS TO ENTRY

What can act as a BTE? The list is very long. All of the following can provide a

barrier to entry for firms outside the industry. Many other barriers to entry also

exist.

LEGAL RESTRICTIONS

Government (at the federal, state, and local level) sometimes grants toindividual firms the exclusive right to provide some good or service to buyers.

For instance, the U.S. Postal Service has a monopoly over regularly scheduled

daily delivery and pickup of mail. The food concession in a municipal stadium

is a monopoly created by a local government. And, local governments often

grant monopolies to cable companies.

PATENTS

Governments grant patents to inventors. These patents give to the inventor the

exclusive right to control the use of the invention. The reason governments

grant patents is to give an incentive for inventive activity.

TECHNICAL SUPERIORITY

Sometimes a business is so good at what they do, no one else can possibly

compete with them. For instance, in the 1960s IBM was so good at producing

mainframe computers that few could compete with them.

ECONOMIES OF SCALE

Economies of scale give large producers a significant cost advantage over small

rivals. Where a firm has grown very large and significant economies of scale

exist, they can rest easy: new competitors generally start small and therefore

have much higher unit production costs than the giant firm. These new, small

rivals find it nearly impossible to survive again the large rival because they just

cant be price competitive given their much larger unit production costs.


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FINANCIAL REQUIREMENTS TO ENTER INDUSTRY

Entering certain industries often requires vast amounts of money. For instance,

to enter the auto industry you likely need billions of dollars. The same holds

true for many other industriesso much money is required that very few

outsiders can ever hope to enter the industry. This major financial requirement

services as a significant barrier to entry for many industries.

CONTROL OF A SCARCE RESOURCE OR INPUT

Sometimes a particular hard-to-find resource or input is needed to produce a

good or service. If a company can gain control over this resource or input, they

can gain a monopoly: only they will be able to produce the good or service

because only they have access of the required input.

ENTRY-DETERRING BEHAVIOR

A firm can protect itself from competition by deliberately acting in a way that

convinces potential competitors to not enter the industry. Some firms spendhuge amounts of money on advertising to keep new rivals from starting up

business. Or, firms can act exceedingly aggressive if faced with new competition

by perhaps starting a major price war every time a new competitor enters their

market. Lawsuits against new rivals have been used to drive them out of

business or to, at the very least, raise the cost of entering the business to very

high levels.

BARRIERS TO ENTRY AND PROFITABILITY

With a high level of BTE, new competitors are unlikely to appear in the

industry and competition is generally limited to firms already within theindustry. This has a very important consequence.

Competition leads to winners and losers. As the losers exit the industry, a

smaller number of old firms exist. This leads potentially to higher profits for the

remaining firms. But, if barriers to entry keep out new competitors, these high

profits might remain.

Barriers to entry help create high profit industries in an economy. Other

industries that do not benefit from significant barriers to entry remain

perpetually low-profit industries.


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BARRIERS TO ENTRY AND THE NUMBER OF FIRMS IN AN

INDUSTRY

One indirect (but imperfect) sign of high barriers to entry and one indirect (but

imperfect) sign that high profits might exist in an industry is a small number of

firms in the industry.

Competition leads to winners and losers. Barriers to entry restrict the entry

of new firms into the industry. Over time, then, industries with barriers to entry

will often end up with a relatively few firms. And, these firms will often earn

profits higher than in other industries with low barriers to entry.

Over time, the number of firm in an industry might stabilize at, say, 5,000 if

there are almost no BTE. In other industries, the number of firms might

stabilize at 200 if moderate BTE exist. In still other industries, the number of

firms might stabilize at 5 firms if fairly high BTE exist.

A relatively small number of firms is not only an indirect (but imperfect)

indicator that BTE and profits are high, it also independently contributes to a

reduction in competition and to higher profits.

EROSION OF BARRIERS TO ENTRY

Moderate and high barriers to entry can give firms within the industry good

profits. Firms outside the industry, however, cannot easily enter the industry

because of these barriers to entry.

However, if profits are high enough in these industries outsiders will try to

find some way to enter the industry. As time passes, more and firm outside

firms find ways to break though the barriers to entry.

For instance, perhaps outsider firms find a way to produce the produce

cheaply with new technology. Or, perhaps they innovate and find a better

product than that sold by firms within the industry. Or, perhaps patent

protection runs out and new firm are now able to enter the industry.

Almost all barriers to entry are temporary. Eventually they are overcome by

outsiders or they disappear on their own. This might take many yearsperhaps

decadesbut high-profit industries protected by high barriers to entry will

eventually disappear.

12-Evolution of Industries and BTE

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