Entry Deterrence

Definition

Entry deterrence refers to strategies used by incumbent firms to prevent potential competitors from entering a market. This can include actions like lowering prices, increasing production capacity, or creating barriers to entry such as strong brand loyalty and exclusive contracts. The goal is to maintain market power and protect profits by dissuading new entrants who could erode market share and profitability.

5 Must Know Facts For Your Next Test

1. Entry deterrence can lead to a more stable market for incumbents but can also reduce overall consumer welfare by keeping prices high.
2. Firms may invest in capacity expansions or R&D as a signal to potential entrants that they are committed to maintaining market dominance.
3. Long-term commitment strategies can include exclusive agreements with suppliers or retailers that limit competitors' access to essential resources.
4. Predatory pricing is a controversial tactic where established firms temporarily lower prices below cost to drive out or deter new entrants.
5. Regulatory measures can sometimes prevent or discourage entry deterrence practices that are deemed anti-competitive or harmful to market health.

Review Questions

• How do barriers to entry contribute to the effectiveness of entry deterrence strategies?
  • Barriers to entry play a crucial role in entry deterrence by creating obstacles that make it challenging for new firms to enter the market. Incumbents can leverage these barriers—such as high startup costs, brand loyalty, or regulatory hurdles—to discourage potential competitors. By strengthening these barriers through strategic actions like exclusive contracts or significant investments, existing firms can reinforce their market position and reduce the likelihood of new entrants.
• Evaluate the ethical implications of using predatory pricing as a method of entry deterrence.
  • Predatory pricing raises significant ethical concerns as it involves setting prices below cost to eliminate competition. While it may benefit consumers in the short term through lower prices, the long-term effect is often detrimental to market health as it can lead to monopolistic behavior once competitors are driven out. This practice can create an uneven playing field, hinder innovation, and ultimately harm consumers by resulting in higher prices and reduced choice once competition is stifled.
• Assess how the presence of strong incumbent firms affects market dynamics and the potential for new entrants.
  • The presence of strong incumbent firms significantly shapes market dynamics by establishing a competitive environment that can deter new entrants through various strategies such as entry deterrence. Incumbents may use their established resources, brand reputation, and economies of scale to create an intimidating barrier for newcomers. As these firms employ tactics like price wars or exclusive supplier agreements, they not only protect their market share but also contribute to an environment where innovation may stagnate due to limited competition. This complex interplay can lead to monopolistic structures that inhibit economic growth and consumer welfare.

Related terms

Barriers to Entry: Obstacles that make it difficult for new firms to enter a market, which can include high startup costs, regulatory requirements, and established brand loyalty.

Price War: A competitive exchange between rival companies who lower prices to undercut each other, often used as a tactic in entry deterrence.

Market Structure:

The organizational characteristics of a market that influence the behavior of firms and the nature of competition, such as monopoly, oligopoly, or perfect competition.