What is the Threat of New Entrants?
There is a threat that exists in pretty much any industry: if profits seem high from the outside, others will come and a more crowded market will in almost all cases lead to vendor segmentation and lower profits.
In general, the attractiveness of a market and in turn the threat of new companies trying to enter, will be lower if:
- There’s a high risk of stranded costs: This happens if new entrants have to make investments that would be hard to recoup if the business doesn’t go as well as they expected. If they needed to invest in specialized machinery, for example, their investment may be at risk of becoming a capital sunk cost they may not be able to recover.
- Incumbents have a privileged position: For example, exclusive access to distribution channels, large economies of scale, intellectual property or strong brands.
- Incumbents are known for being aggressive to new entrants: If at least one of the incumbents is well known for retaliating aggressively against new entrants, that could be a deterrent for companies tinkering with the idea of entering the market.
What prevents potential entrants from attacking a market is their “perception” of the existing balance (or lack thereof) between the risks associated with
If they feel that they can enter a good market with reasonably low risks they will most likely do that, but if instead they perceive that the risks of losing money and reputation are high, they will be more likely to stay out.
How to Mitigate the Threat of New Entrants
Here are some ideas that can help you keep entry risks high:
- Investing aggressively in
promotion: The risks of competing in a market against high spenders should deter the intentions of potential entrants. Your promotion efforts should be directed at brand recognition, deepening connections with your current customer base and making your products accessible to as many potential buyers as possible.
- Investing aggressively in fixed costs: It may seem counterintuitive, but investing in specialized assets that could give you a competitive edge, such as lower unit costs or higher performance, would increase the cost of competing in the market, helping you diminish the intentions of potential entrants who would be afraid of ending up with high stranded costs if they later decide to get out and can’t sell their assets.
- Securing exclusive access to key sales and distribution channels and resources: One advantage you have being an incumbent is that you already know the channels and partners that work and the ones that don’t. Securing exclusive access to some of these key channels or resources (locations, key inputs, etc.) can be enough to keep new entrants at the other side of the fence.
- Building strong relationships with key stakeholders: Having good standing relationships with key influencers, regulators, media, customer groups and others can go a long way when trying to deter the attack of new entrants.
If a new player actually gets to enter the market, you and other incumbents should retaliate aggressively against the new player, even if small, to send the message to other potential entrants.
You should, however, avoid using price as a deterrent to new entrants, for example lowering prices to make the market look unattractive.
As we saw earlier, if the new entrant is a low-price competitor, it will most likely be able to make money through a lower-cost business model, which may be not possible for you to compete against with your existing value chain. Because of that, lowering prices will probably not get rid of them, since they may be able to survive a price war longer.
This article has been extracted from Sun Wu’s book Strategy for Executives which can now be downloaded for free here.
Porter, Michael E. Competitive Strategy: Techniques for Analyzing Industries and Competitors. Free Press. Kindle Edition.
Magretta, Joan. Understanding Michael Porter: The Essential Guide to Competition and Strategy. Harvard Business Review Press. Kindle Edition.