Profitable industries that yield high returns will attract new entities. New entrants eventually will decrease profitability for other firms in the industry. Unless the entry of new firms can be made more difficult by incumbents, abnormal profitability will fall towards zero (perfect competition), which is the minimum level of profitability required to keep an industry in business.
The following factors can have an effect on how much of a threat new entrants may pose:
- The existence of barriers to entry (patents, rights, etc.). The most attractive segment is one in which entry barriers are high and exit barriers are low. It’s worth noting, however, that high barriers to entry almost always make exit more difficult.
- Government policy such as sanctioned monopolies, legal franchise requirements, or regulatory requirements.
- Capital requirements – clearly the Internet has influenced this factor dramatically. Web sites and apps can be launched cheaply and easily as opposed to the brick and mortar industries of the past.
- Absolute cost
- Cost advantage independent of size
- Economies of scale
- Product differentiation
- Brand equity
- Switching costs are well illustrated by structural market characteristics such as supply chain integration but also can be created by firms. Airline frequent flyer programs are an example.
- Expected retaliation – For example, a specific characteristics of oligopoly markets is that prices generally settle at an equilibrium because any price rises or cuts are easily matched by the competition.
- Access to distribution channels
- Customer loyalty to established brands. This can be accompanied by large brand advertising expenditures or similar mechanisms of maintained brand equity.
- Industry profitability (the more profitable the industry, the more attractive it will be to new competitors)