The threat of new entrants is a term that describes the threat posed by new companies as they enter into a market. It is one of porter’s five forces that is used in analyzing the strengths and weaknesses of an industry.
The threat of new entrants is important to every company that is currently competing in any given market because it determines how much profit that is shared around.
If a new company enters into a market and offers a similar product to that which is already being offered by the existing companies.
The law of supply and demand kicks in meaning more products and less demand. As a result, the companies have to drop their prices in a bid to attract more customers which results in lower profits.
Even without changing the prices of the products, the new company will still grab a share of the market which still entails that the existing companies get to take home less profit than they would have the new company not participating in the market.
This is why threats of new entrants shape the market landscape by determining the level of competition and profitability of the industry.
Two things are considered when analyzing the threat to entry in an industry. These are; is the threat of new entrants high or is it low? Here’s why it is important.
High threats of new entrants
An industry with a high threat of new entrants will likely have a promise of high profits. This attracts new companies who then enter the industry and destabilize it either by forcing the existing companies to reduce product quality in order to maintain their profit margin or lower the prices of their products.
So an industry that was once attractive with the possibility of making huge profits now has more competition and less profit potential.
Low threats of new entrants
Low threats of new entrants mean that the industry has few competitors and so existing companies hardly face any threat from new companies. Companies in industries with a low threat of new entrants thus enjoy high-profit margins for a very long time.
So what determines if an industry has a high or low threat of new entrants? It is the barrier to entry. Barriers to entry refer to the factors or conditions that make it difficult for a new company to enter a particular industry.
Industries with high barriers to entry will have low threats of new entrants whereas those with low barriers to entry will have higher threats of new entrants.
Characteristics of industries with a high threat to new entrants
- low initial capital requirement
- Poor government regulations
- Lack of a strong brand identity
- Low brand loyalty
- Easy access to suppliers and distributors
- No need for proprietary technology
- No threat of retaliation from existing companies
Characteristics of industries with a low threat to new entrants
- high initial capital requirement
- Strong government regulations
- Presence of companies with strong brand identities
- Limited access to suppliers and distributors
- Proprietary technology needed to enter
- High threats of retaliation from existing companies
- Strong brand loyalty
How to respond to threats of new entrants
1. By limiting pricing - existing companies can reduce the prices of products such that new companies find it difficult to compete
2. Using deterrents like showcasing the strong brand loyalty in the industry, and offering tasty promotions.
3. By applying predatory pricing tactics - existing companies can price their products way below the acceptable prices such that no profits are made.
Related: Barriers to entry