What are Barriers to Entry?

Barriers to entry represent obstacles limiting individuals or entities from entering a particular market. These hindrances might be experienced by individuals, businesses or regions attempting to break into an established industry, trade or field. Such a barrier also restricts competition and can compromise new business. In business, barriers to entry grant pricing power to an established entity, also known as an incumbent. Although these barriers allow for only the most qualified and competitive members to thrive, which is a function of capitalism, these roadblocks might also serve as a hindrance, creating a business environment where consumers are forced to pay high prices for products or services because of a lack of options.

There are a number of factors that might create barriers to entry, one of which is cost. Economies of scale often allow incumbent businesses to purchase large sums of a product at low rates simply because they have a long history or are buying in bulk. Incumbent businesses are better able to slash prices and still earn profits because of this economy of scale. A new market entrant might not be able to buy as much before a business begins generating cash flow, and therefore will pay more for the same product, which places the newcomer at a cost disadvantage compared to its larger rival.

Another barrier to entry involves patents and is prevalent in the pharmaceutical industry. Once a company develops a drug and obtains exclusive rights to that medicine, a rival drug company cannot develop a cheaper, generic form of that drug before a patent's expiration. Patents often are in place for a number of years, and this creates barriers to entry for some drug makers. Once a patent is lifted, however, generic drug makers can step in and replicate a medication, thereby providing options to consumers.

Other areas where barriers to entry exist include places where a monopoly business operates. Business monopolies become the sole provider of a product or service and are faced with no nearby competition. If an entity becomes so large that new entrants are prohibited from entering a market and competing, consumers have few price options. The monopoly gains the ability to control not only price but also quantity in a market, which places consumers at a disadvantage.

In developed economies, regional governments have established antitrust laws to reduce monopolistic practices created by barriers to entry. These rules promote competition in a market, and regulators are often granted the final word before a company is permitted to become dangerously large. For instance, in the United States and in Europe, regulators might prevent a merger between two large companies if the combination threatens to create a monopoly in a given industry.