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| Brick By Brick |
Robert
Smile surveyed over three hundred companies on their use of entry-deterring strategies.
His findings are reproduced in Besanko et al. (2013). Smile examined the use of
these firms in terms of the learning curve, advertising, patent acquisition,
limit pricing, and excess capacity. All of these were examined in terms of the
use for new products and existing products. The data are pretty clear in that use
of advertising is the predominate entry-deterring strategy used by companies in
the sample. Companies use intensive advertising in 62% of cases with a new
product and in 52% of cases with existing products (p. 219).
Use of entry barriers exist because there
is a profit advantage in controlling market share. Entrants to a market move
the supply curve to the left but do not necessarily move the demand curve. This
means that ceteris paribus, the equilibrium price of the product under
consideration will be lower than it was before a rival firm’s market entry, and
the quantity demanded will be divided between the incumbent and the new
entrant. This drives down both profit and revenue. A rational actor will work
to limit entry to their market.
The main problem with some of the
options in limiting market entry is that they do not necessarily work in a
dynamic system. If a firm either tries to keep prices low to prevent entry or
maintain excess capacity, they may seem to make sense in a toy model with two
time periods, but the actual market is changing and exists in a world of
infinite time periods. Over time, if a firm were exercising limit pricing as a
monopoly with limit pricing, it would see zero economic profit. If it were
instead willing to share the market, as an oligopoly, then they would be able
to see some profit above zero (Besanko et al. pp. 208). The same applies for holding excess capacity. A firm cannot be
expected to hold that capacity forever. And as the saying goes, what cannot go
on forever, will not. The fact that
these options do not necessarily work ties in with the fact that in many
countries such theoretically anti-competitive practices are illegal.
The other side is looking at what works
and what is used. Firms predominately use advertising to create product
differentiation and limit market entry. A look at the top advertisers will
illustrate this. Of the top twenty-five advertisers, several industries stand out.
The cell phone industry’s big four are all represented. The list also includes
five automakers, three insurance companies, five large retailers, two fast food
companies, and three tech companies. The only real surprise is that there is
only one beer company (“America's 25 Biggest Advertisers”). The common feature
is that these are some of the biggest companies in America, so they can afford
to spend a lot on advertising, but they all compete in fairly concentrated
markets. Advertising is not just a way to maintain and steal market share from
competition firms, but it creates a barrier to entry. To be fair, some of these
industries have high barriers to entry for a new firm, but it also impedes
other nation’s companies from market entry because the brands are part of the
environment in a way that a new entrant could only hope to be. In terms of
protecting market-share, advertising and marketing is the smart move for any
executive.
References
Advertising Age. (2013, July 8). Infographic: Meet America's 25 Biggest
Advertisers. Advertising Age. Retrieved from http://adage.com/article/news/meet-america-s-25-biggest-advertisers/242969/
Appleby, J. (2014, May 2). New hepatitis C Drugs’ Price
Prompts an Ethical Debate: Who Deserves to Get Them?
Washington Post. Retrieved from http://www.washingtonpost.com/business/new-hepatitis-c-drugs-price-prompts-an-ethical-debate-who-deserves-to-get-them/2014/05/01/73582abc-cfac-11e3-937f-d3026234b51c_story.html
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