A Taxonomy of Barriers to Entry

• (2) Network Effects

 Network effects describe the positive effect that one user

of a product or service has on the value of that product or
service for other users. When network effects are present,
the value of the product or service increases with the
number of users. This is an example of a positive externality.

 For example, Facebook, with over 2 billion active users

worldwide enjoys tremendous network effects.

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 A Taxonomy of Barriers to Entry

• (3) High Switching Costs

of Buyers

 E.g., changing may require

employee retraining
(e.g., computer software).

• (4) Capital Requirements

 E.g., Tesla invested $5 billion in a

battery giga-factory in Nevada.

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• (5) Intended Excess Plant Capacity

 Building extra plant capacity for the

intended purpose of deterring entrants
from entering the industry.
(Note: potential free-rider problems)

 Excess capacity deters entry by increasing the

credibility of price cutting as an entry response
by incumbents (ex: Dupont in the production of
Titanium Dioxide for paint)

 “Innocent” excess capacity:

Demand is cyclical; Demand falls short of
expectations; Demand is expected to grow.
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• (6) Product Differentiation

 Brand loyalty and customer loyalty to incumbent products

may be a barrier to potential entrants (e.g., Coca-Cola).
Product differentiation appears to be an important entry
barrier in the market for over-the counter drugs and in the
brewing industry.

 As another example,Tesla owners feel an emotional

connection to the company because they deeply believe in
the company’s vision to “accelerate the world’s
transition to sustainable energy” (p.86).

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(7) Favorable Access to Raw Materials

 Alcoa --> bauxite
 Exclusive dealing arrangements
 Favorable geographic locations

(8) Access to Distribution Channels

 The manufacturer of a new food product,
for example, must persuade the retailer to
give it space on the fiercely competitive
supermarket shelf via promises of
promotion, and intense selling efforts to
retailers.
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