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In 2012, firms that will leave the industry by 2017 are only about one-third the size of the average firm.
3.Most entrants do not survive 10 years, but those that do grow precipitously. Of the 30 to 40 firms that enter the market between 2012 and 2017, roughly 60 percent will exit by 2022. The survivors will nearly double their size by 2022.
4.Entry and exit rates vary by industry. Many industries have high entry rates including apparel, lumber, and fabricated metals. Industries with high exit rates included apparel, lumber, and leather. Industries with little entry included tobacco, paper, and primary metals. Industries with little exit included tobacco, paper, and coal. Entry and exit are highly related: Conditions that encourage entry also foster exit.
A more recent study of manufacturing firms in the United Kingdom by Disney, Haskel, and Heden confirms that entry and exit are pervasive.2 Their study finds twoyear entry and exit rates of 16 percent. After five years, 65 percent of firms have exited. Entry and exit is more common in leather goods, footwear, and office machinery, but uncommon in metal manufacturing, synthetic fibers, and plastics processing.
These facts have three important implications for strategy:
1.When planning for the future, the manager must account for entry. While the exact identity of an entrant is hard to predict, the incumbent should expect the entrant to be either a small greenfield enterprise or a large diversifying firm.
2.Managers should expect most new ventures to fail quickly. However, survival and growth usually go hand in hand, so managers of new firms will have to find the capital to support expansion.
3.Managers should know the entry and exit conditions of their industry. Entry and exit are powerful forces in some industries but relatively unimportant in others.
ENTRY AND EXIT DECISIONS: BASIC CONCEPTS
In this chapter we present economic concepts that will help managers who are deciding whether to enter or exit a market, as well as managers attempting to cope with potential new entrants. We begin with some basic terminology. It helps to think of entry as an investment. The entrant must sink some capital that cannot be fully recovered upon exit—it is this element of risk that makes the entry decision difficult. The entrant hopes that postentry profits (i.e., the excess of revenues over ongoing operating expenses) exceed the sunk entry costs.3 There are many potential sunk costs to enter a market, ranging from the costs of specialized capital equipment to government licenses. Many sunk entry costs are associated with the fixed costs that give rise to economies of scale, which we discussed in Chapter 2, such as the cost of building a factory or performing R&D. But the factors that give rise to entry costs and economies of scale are not identical. Recall that fixed costs are sunk costs only if the fixed costs are not recoverable. And some sources of scale economies are not fixed costs, such as inventory management.
Postentry profits will vary according to demand and cost conditions, as well as the nature of postentry competition. Postentry competition represents the conduct and performance of firms in the market after entry has occurred. For example, the entrant might anticipate that firms will behave like Cournot quantity setters or Bertrand price setters, as described in the previous chapter, with corresponding implications for postentry profits. The potential entrant may use many different types of information
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about incumbents, including historical pricing practices, costs, and capacity, to assess what postentry competition may be like. The sum total of this analysis of sunk costs and postentry competition determines whether there are barriers to entry.
Barriers to Entry
Because the potential for profits is a siren call to investors, a profitable industry invites entry. Barriers to entry allow incumbent firms to earn positive economic profits while making it unprofitable for newcomers to enter the industry.4 Barriers to entry may be structural or strategic. Structural entry barriers exist when the incumbent has natural cost or marketing advantages, or when the incumbent benefits from favorable regulations. Strategic entry barriers result when the incumbent takes aggressive actions to deter entry. Whether structural or strategic, these entry barriers either raise sunk entry costs or reduce postentry profitability.
Bain’s Typology of Entry Conditions
In his seminal work on entry, economist Joseph Bain argued that markets may be characterized according to whether entry barriers are structural or strategic, and whether incumbents can profit from using entry-deterring strategies.5 Bain described three entry conditions:
Blockaded Entry Entry is blockaded if structural barriers are so high that the incumbent need do nothing to deter entry. For example, production may require large fixed investments relative to the size of the market (high sunk entry costs), or the entrant may sell an undifferentiated product for which it cannot raise price above marginal cost (low postentry profitability).
Accommodated Entry Entry is accommodated if structural entry barriers are low, and either (a) entry-deterring strategies will be ineffective or (b) the cost to the incumbent of trying to deter entry exceeds the benefits it could gain from keeping the entrant out. Accommodated entry is typical in markets with growing demand or rapid technological improvements. Entry is so attractive in such markets that the incumbent(s) should not waste resources trying to prevent it.
Deterred Entry Entry is deterred (a) if the incumbent can keep the entrant out by employing an entry-deterring strategy and (b) if employing the entry-deterring strategy boosts the incumbent’s profits. Frank Fisher calls such entry-deterring strategies predatory acts.6 Predatory acts may either raise entry costs or reduce postentry profits. We describe several predatory acts later in this chapter.
Bain argued that an incumbent firm’s approach to potential entry should depend on market conditions. If entry is blockaded or accommodated, the firm should not make any effort to deter entry. If blockaded, the effort is superfluous; if accommodated, the effort is wasted. If entry is deterred, the firm should consider engaging in a predatory act.
Analyzing Entry Conditions: The Asymmetry Requirement
Bain’s typology has great intuitive appeal but does not address an important question: What is the strategic distinction between entrants and incumbents? As we will see, most of the predatory strategies available to incumbents are also available to entrants.
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EXAMPLE 6.1 HYUNDAI’S ENTRY INTO THE STEEL INDUSTRY
Hyundai, Korea’s largest firm, started as a construction business and expanded into engineering, automobile, shipbuilding, and other heavy equipment manufacturing. Although most of the Korean conglomerates overlap in many industries, Hyundai has had a greater focus on heavy industrial sectors. (Samsung, the next largest Korean conglomerate, is regarded as more of a consumer products company.) Even so, Hyundai in the 1990s was a bit player in the steel market, with a few small specialty mills. But when Hyundai announced in 1997 that it would build a huge fully integrated blast furnacetype steel mill with a capacity of 6 million tons a year, many in the nation were surprised. The government had opposed Hyundai’s entry into the steel market, and this decision became one of the nation’s hottest economic issues.
Hyundai had long been eager to expand its presence in steel production. The dominant firm, POSCO, which until 1998 was majorityowned by the government, had two big steel mills with combined production capacity of about 26 million tons. No other company in Korea has a mill approaching even 6 million tons, which is generally regarded to be the minimum efficient scale. Given its cost advantage, POSCO was and remains one of the most profitable companies in Korea. Experts in the Korean steel business noted that POSCO’s supply was critical; without POSCO, its customers would have to turn to imports. Hyundai felt that demand for steel would continue to grow, far outstripping POSCO’s production capabilities.
With demand forecast to grow, Hyundai felt that the market was ripe for entry. Hyundai felt it could be more efficient than POSCO, which was thought to have much redundancy and bureaucracy. Moreover, Hyundai consumes so much steel itself that it could achieve minimum efficient scale without selling to the market. By ensuring capacity, Hyundai might also be better able to plan its other operations (such as car or ship production) more flexibly and easily. Finally, Hyundai felt that the steel mill would be the most cost-effective way to pull far ahead of Samsung in the battle to be Korea’s top firm.
The Korean government discouraged Hyundai from building the plant, claiming that demand was likely to slacken. The real motive may have been the government’s decision (not yet publicized) to privatize POSCO. In any event, the government stalled but eventually failed to dissuade Hyundai from building the plant. Hyundai broke ground for the plant in 2006 and began operations in 2010. In the interim, Hyundai acquired several smaller Korean steel companies, including Sammi Steel and Dangjin Steelworks.
As it turned out, Hyundai’s forecasts for steel demand were partially correct. Economic growth since the late 1990s has been uneven. Hyundai has also enjoyed mixed fortunes. The chaebol (see Chapter 4) has been partially dismantled, but some of the remaining companies, including Hyundai engineering, have enjoyed remarkable growth.
For example, in a strategy known as predatory pricing, the incumbent firm slashes prices in an effort to drive out a new entrant. It is possible that the new entrant could slash prices in an effort to drive out the incumbent (something Wal-Mart allegedly does on occasion when it enters new markets). Incumbents and entrants will naturally differ in financial resources and productive capabilities, but the incumbent does not necessarily have the advantage.
There must be other asymmetries that usually work in favor of the incumbent. Incumbents usually have incurred sunk entry costs while entrants have not. Consider Boeing and Airbus, which are protected from entry by other potential manufacturers of large commercial aviation airframes because they have already made hundreds of