Strategy - Entering a Market
The pros and cons of entering a market by Judith A. Chevalier
Introductory economics textbooks gene rally tell us to expect new entrants into an industry whenever the incumbent companies are earning profits greater than their cost of capital. Furthermore, we are told that entry will occur until profits net of the cost of capital are driven to zero. Obviously, this view of the world is too simplistic. We can think of many examples of markets with no regulatory barriers to entry in which incumbent companies are making high profits, yet little or no entry occurs. For example, in a 1999 working paper, Boston University economist Marc Rysman estimates that the profits of US Yellow Pages directory publishers average 35 to 40 percent of revenue. Despite this, relatively few independent publishers have entered the market to compete with local telephone companies in providing Yellow Pages services. In contrast, we can think of several examples of markets like online bookselling where, despite the virtual absence of profitability, many new companies seem to be starting up. In this article, I will explore sorne of the factors a company should consider when deciding whether or not to enter a new market. In doing so, I wiU try to reconcile the entry patterns we observe in real business with the basic principIes of economics.
Basic economics of entry
Consider the textbook case of entry dynamics. A company enters a new market and finds it profitable. Typically, that market will then attract further entry, eroding the pioneer's profitability. Profits are eroded for two reasons. First, the pioneer loses
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2 ·Strategy and micro-economics
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market share to new entrants. Second, the presence of the entrants often brings vigorous price competition, eroding margins on each unit soldo The case of Rollerblade skates, now owned by Italy's Benetton Sportsystem, conforms fairly well to the textbook example. Rollerblade introduced inline skates in the US market in 1980. At
Introductory economics textbooks gene rally tell us to expect new entrants into an industry whenever the incumbent companies are earning profits greater than their cost of capital. Furthermore, we are told that entry will occur until profits net of the cost of capital are driven to zero. Obviously, this view of the world is too simplistic. We can think of many examples of markets with no regulatory barriers to entry in which incumbent companies are making high profits, yet little or no entry occurs. For example, in a 1999 working paper, Boston University economist Marc Rysman estimates that the profits of US Yellow Pages directory publishers average 35 to 40 percent of revenue. Despite this, relatively few independent publishers have entered the market to compete with local telephone companies in providing Yellow Pages services. In contrast, we can think of several examples of markets like online bookselling where, despite the virtual absence of profitability, many new companies seem to be starting up. In this article, I will explore sorne of the factors a company should consider when deciding whether or not to enter a new market. In doing so, I wiU try to reconcile the entry patterns we observe in real business with the basic principIes of economics.
Basic economics of entry
Consider the textbook case of entry dynamics. A company enters a new market and finds it profitable. Typically, that market will then attract further entry, eroding the pioneer's profitability. Profits are eroded for two reasons. First, the pioneer loses
51
2 ·Strategy and micro-economics
-
market share to new entrants. Second, the presence of the entrants often brings vigorous price competition, eroding margins on each unit soldo The case of Rollerblade skates, now owned by Italy's Benetton Sportsystem, conforms fairly well to the textbook example. Rollerblade introduced inline skates in the US market in 1980. At