7 Forces that Help Businesses Dominate Markets

by | Jul 11, 2022

In The Five Competitive Forces That Shape Strategy, Micheal E. Porter describes 7 barriers to entry that prevent new businesses from entering a market.

Companies that operate in industries with these barriers are strongly positioned to maintain market share and pricing power.

1. Supply-side economies of scale

A supply-side economy of scale is when a producer can create large volumes at a lower cost than their competitors. This can be achieved through more efficient technology or better terms with suppliers.

New businesses must either enter the market at a larger scale or accept a cost disadvantage.

Intel has supply-side economies of scale in chip making and research and development.

2. Demand-side benefits of scale

Demand-side benefits of scale are also known as network effects. A business has a network effect when its product becomes more attractive the more users it has.

eBay has demand-side benefits of scale because buyers and sellers know this is the best place to find trading partners.

Demand-side benefits of scale prevent new businesses from entering the market because customers are less likely to buy from them. The new business will need to lower its prices until it can build trust and a customer base.

3. Customer switching costs

Switching costs are costs a customer faces when they change suppliers. Switching costs include retraining employers to use a new product, altering product specifications, and modifying processes.

Adobe has switching costs because it takes considerable time and effort to learn its suite of products. The cost of training employees to use a different product would be high.

4. Capital requirements

The initial investment to enter a market can be so high that it prevents many newcomers. Capital may be required to build facilities, extend credit, purchase inventories, and sustain operating losses.

Capital requirements are a substantial barrier where the capital is unrecoverable, such as spending on advertising or research and development. It is less of a barrier when the capital can be recovered, for example, an airline can recover its capital by selling its planes to other airlines.

The mining and energy industries have high and sometimes unrecoverable capital requirements for exploration, drilling and extraction of resources which prevent new entrants to the market.

5. Incumbency advantages independent of size

Existing companies can have advantages over new entrants not relating to their size. These advantages include better technology, preferential access to raw materials, favorable geographic location, established branding or greater experience.

6. Unequal access to distribution channels

A new company must develop a distribution network to sell its product. This can be difficult when the newcomer must displace the current product.

Supermarkets have limited shelf space. It would be nearly impossible for a new soda company to convince the supermarkets to put its product on the shelves in place of Coca-Cola’s.

New entrants can try to bypass this barrier by selling directly to consumers. The internet has made this easier for businesses.

7. Restrictive government policy

Government policy can make it difficult for new companies to enter the market by requiring licenses and permits, or flat out banning them. For example, Facebook and Twitter are banned in China and Tik Tok is banned in India.

These policies can open the market to domestic companies such as WeChat in China. 

A company that commands any one of these 7 forces has an easier time maintaining market share and pricing power. Newcomers will face difficulties in these markets and will often try to find ways to circumvent these barriers.

Michael E. Porter is the Bishop William Lawrence University Professor at Harvard University, based at Harvard Business School in Boston. He is a six-time McKinsey Award winner, including for his HBR article, “Strategy and Society,” co-authored with Mark R. Kramer (December 2006).

0 Comments

Submit a Comment

Your email address will not be published. Required fields are marked *

More Articles Like this

How to Tell if a Business is Healthy, Growing & a Good Investment

How to Tell if a Business is Healthy, Growing & a Good Investment

If you invest in stocks, you must know how to read an Income Statement. It reveals if a company is profitable, growing, and worth further research. But Income Statements can be confusing to read. So, here’s an easy-to-follow system, with everything you need to know....

Spinoffs: The Special Opportunities to Earn Big Returns

Spinoffs: The Special Opportunities to Earn Big Returns

What is a spinoff? “A spinoff is when a company takes a subsidiary, division or part of its business and separates it from the parent company creating a new, independent, freely standing company.” Joel Greenblatt, You Can Be A Stock Market Genius On 24 August 2020...

Benjamin Graham’s Simple Way to Select Bargain Stocks

Benjamin Graham’s Simple Way to Select Bargain Stocks

In 1976 Benjamin Graham did an interview with Medical Economics titled The Simplest Way to Select Bargain Stocks. Within the article, Graham described his new investment formula. Graham back-tested the method from 1926-1976 and concluded that such a strategy would...

Get our favorite tools for finding stock ideas

 

Download our Free Toolkit for the Value Investor

Want to know what stocks Buffett, Munger, Ackman and Marks are buying?

 

This free guide will give you the tools to:

 

See what stocks fund managers are buying

See what politicians have recently bought

Analyse a company's financials

Screen for potential investments

and value stocks

 

You have Successfully Subscribed!

Ebook cover 4 STEPS TO INVESTING IN UNDERVALUED STOCKS

Looking for a way to find undervalued stocks?

 

This free blueprint will take you through the steps of investing in undervalued stocks just like Warren Buffett 

 

You will learn how to:

 

Screen for 'Warren Buffett' type stocks.

Analyse a company's history.

Research a company.

Prepare yourself to value a company. 

 

 

You have Successfully Subscribed!