Barriers to Entry : An Extended Model
Dr Christopher Clark
Division of Economics and Financial Studies, Macquarie University, Australia
Email: [email protected]
Professor Lesley White*
Faculty of Pharmacy, University of Sydney, Australia
Email: [email protected]
Preferred Stream: 14 – Strategic Management
Profile:
*Dr Lesley White is a Professor at the University of Sydney, where she is coordinating the
research and teaching in the new field of Pharmacy Management. Lesley’s interests focus on
strategic marketing and services marketing, particularly services quality, together with small
business and professional services marketing. Her qualifications include a BPharm, MCom and
MEd. Lesley’s PhD is from Sydney University with a thesis addressing decision making in a
professional services context.
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Barriers to Entry : An Extended Model
ABSTRACT
The strategic attractiveness of an industry can be assessed (inter alia) through the analysis of entry
barriers. This study examines the perceptions of the members of the Australian retail pharmacy industry
regarding the strength of potential barriers to entry into the industry. We propose and utilise a novel
framework for entry barriers analysis, which includes the perceived locus of control for each entry barrier.
The study uses both qualitative and quantitative methodology to categorise potential barriers to entry in
these terms.20 in depth interviews were conducted with various stakeholders and 132 retail pharmacists
completed questionnaires. Although the ideal entry barrier would be both effective and have an internal
locus of control, the study suggests that this industry is relying on barriers which while arguably effective,
are outside the industry’s control, indicating a level of unjustifiable complacency. This research is of
significant managerial relevance since the current players face facing potentially devastating impacts if
supermarkets or other new competitors were to enter the market.
Keywords : Industry dynamics/Competitive interaction
Entry barriers, as a factor in determining the strategic attractiveness of an industry, and the strategic
position of the players within that industry, have been at the heart of the industrial organisation (IO)
economics since Bain (1956) identified that markets could be characterised by a “condition of entry” –
defined as the “advantages of established sellers in an industry over potential entrant sellers…” (Bain,
1956). The IO view was expanded and popularised by the work of Michael Porter (1980) and his use of
entry barriers as one of the five forces determining the structural attractiveness of industries. The strategic
use of entry barriers by incumbents to prevent competitor entry is described as entry deterrence, and its
theoretical grounding has been in the expanding field of Game Theory. Entry deterrence has been
described in a number of industries including transport (van der Veer, 2002), hardware and software
(Haan, 2003) and satellite broadcasting (Ghemawat, 1998). This study examines the attitude of members
of a dispersed monopoly provider (the Australian retail pharmacy profession) to potential entry by one or
more powerful competitors and we propose a novel framework of entry deterrence.
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BACKGROUND
Bain (1956) defined entry barriers in terms of the relative advantage of established versus potential entrant
sellers. However, other definitions followed. McAfee et al (2004) note various definitions from the
literature, including: a cost of producing, borne by the entrant, but not borne by the incumbents (Stigler,
1968), a factor which makes entry unprofitable while permitting incumbents to persistently earn monopoly
profits (Ferguson, 1974) and anything that prevents entry when entry is socially beneficial. (Fischer, 1979).
Porter (1980) identified eight key entry barriers. They are economies of scale, product differentiation,
capital costs, buyer switching costs, government policy, access to distribution channels, cost advantages
independent of scale and competitor retaliation. Porter, and separately Yip (1982) attempt to integrate the
IO perspective with the corporate strategy literature.
Salop (1979) classified entry barriers into two forms, which he called “innocent” (those which are
unintentionally erected as side effects of profit maximisation strategies) and strategic (purposely erected to
reduce the possibility of entry). Thus, Porter’s list of entry barriers might be either innocent or strategic,
depending on the context. Economies of scale might be strategic if an organisation deliberately invested in
scale to achieve an entry barrier. Similarly, a buyer switching cost such as familiarity might be considered
innocent, whereas a constructed loyalty program might be seen as strategic. Identification of entry barriers
as strategic implies purposeful use of market forces to maintain monopoly positions. These “entry
deterrence” activities have been investigated in both the mainstream strategy literature and the underlying
game theory literature (for an overview of the link between strategy and game theory, see, for example,
Ghemawat, 2006; Greenwald & Kahn, 2005; Hill & Jones, 2007; Maskin, 1999; Saloner et al., 2001;
Waldman & Jensen, 1998).
Porter (1985) identified three broad strategies to deter entry – the first is for the incumbent to raise
structural barriers, the second is to increase expected retaliation (thus increasing the risk of entry) and the
third is for the incumbent to lower the inducement to entry. Purposefully raising structural barriers
essentially utilises entry barriers in a strategic way (Salop, 1979). Increasing expected retaliation depends
on the incumbent’s ability to credibly signal a willingness and ability to defend its position aggressively.
The third broad strategy is to lower the inducement to attack, for example, by reducing the attractiveness
of the market, and thus reducing the entrant’s expectations of profit. In monopoly markets where there is
a demonstrated correlation between price and volume, the “Theory of Limit Pricing” closely approximates
Porter’s third strategy (lowering the inducement to enter). Limit pricing suggests that the incumbent
should increase volume and reduce prices, thus making the market less attractive for an entrant (Bain,
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1956; Romp, 1997). One specific form of Porter’s strategy of signalling commitment to defend is the
strategy of “pre-commitment”. Such pre-commitment might include capital investment, research and
development, and advertising; all of which indicate a future course of action which deter entry (Romp,
1997).
One issue which has not been explored in the literature is the degree to which the use of a “strategic” entry
barrier is within the control of the incumbent. As a further classification of entry barriers, we have adopted
and adapted the broad construct of the “locus of control” which was first developed by Rotter (1966) and
reflects the perceptions that a person holds regarding who controls most aspects of his/her life. The
construct has been developed and adapted widely to numerous contexts such as finance (Duxbury et al.,
1996), occupational stress (James & Wright, 1993), and health (Strickland, 1978; Wallston et al., 1976).
Although the construct was first developed in the psychology literature as an individual typology, its use
has been applied at the organisational level and specifically in the field of strategic management
(Hodgkinson, 1992).
Our new classification of entry barriers depends on two factors – the perceived effectiveness of the barrier
in preventing potential entry, and the degree to which the leverage of the barrier to implement deterrence
strategies is within the control of the incumbent. The locus of control may vary from being totally outside
the control of the incumbent, to completely within their control. For example government policy, while
acting definitively as an entry barrier, is by definition at least partially out of the incumbent’s control
(unless the incumbent is a government monopoly). This typology allows construction of a matrix where
one axis is the strength of the entry barrier, and the other is the locus of control (internal to external). The
ideal entry barrier would have high strength and an internal locus of control. Our study seeks to utilize this
extended model to investigate the barriers to entry in the Australian retail pharmacy market.
The Grocery Industry’s Interest in the Australian Retail Pharmacy Market
The Australian pharmacy industry is highly regulated, and an agreement between the government, and the
industry association (“the Guild") has ensured that retail pharmacies are the only channel for distribution
of scheduled drugs. The Australian grocery industry is highly concentrated, with three companies holding
approximately 80% of the total market 1 This level of concentration makes the Australian industry the
most concentrated in the developed world.2 In 2005, sales in grocery were approximately $A60 Billion, at
1
http://au.acnielsen.com/site/documents/2006ACNgroceryreportfinallores.pdf
2
http://www.pecc.org/food/papers/2005-2006/Australia/australia-paper.pdf
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an average margin of less than 5%.3 The market is mature, and to ensure continued growth, the major
chains have expanded into new areas of retailing including fresh foods, bakery, butchery, delicatessen (all
by “in store” growth) liquor (predominantly by acquisition) and petrol retailing (acquisition). The impact
on incumbent independent retailers in these areas has been highly disadvantageous, and has led to a severe
rationalisation of each industry, and the closure of many small businesses. In recent years the Australian
supermarket industry has aggressively lobbied the government to open the supply of scheduled
pharmaceuticals to channels other than retail pharmacy, and specifically to supermarkets. This would
establish a similar situation to that found in similar mature markets such as the United Kingdom, and the
United States of America, where large-scale grocery chains (e.g. Walmart in the US and Tesco in the UK)
have become powerful players in the distribution of medicines. For the Australian supermarket industry,
an expansion into Pharmacy operations has a number of potential benefits, primarily growth avenues and
access to products enjoying much higher margins.
The Australian Pharmacy Guild, not surprisingly, has resisted these moves by the supermarket industry
through a defensive public relations campaign, and strong government lobbying. Their efforts were
rewarded in 2005, when the government and Guild renewed the distribution agreement limiting
distribution of scheduled pharmaceuticals to retail pharmacy for a further five years. It is, however,
anticipated that the supermarket industry will continue, and intensify, its lobbying efforts up to the next
Government/Guild negotiation. The industry therefore provides a discrete field of research into the
assessment of entry barriers and choice of entry deterrence.
METHODOLOGY
This study included an exploratory qualitative component followed by a quantitative phase.
The
qualitative phase examined the perceived importance and strength of entry barriers, and the locus of
control within the retail market for scheduled pharmaceuticals in Australia. Semi structured interviews
were conducted with 20 managers representing the various industry stakeholders. These included
executives of the Guild (3), the major pharmaceutical wholesalers (1) (who are also vertically integrated to
provide retail pharmacy services), several large buying groups (2) (strategic groups of pharmacies trading
under a similar or identical brand-names which provide among other things, economies of scale in
purchase), consultants to the industry (2) and retail pharmacists (12)). Interviews were conducted in
person at a convenient location or by telephone and the average duration of each interview was 60 minutes.
3
http://abareonlineshop.com/PdfFiles/PC13169.pdf
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The quantitative phase utilised a self administered survey which was administered to a convenience
sample of retail pharmacists attending an Australian national pharmacy conference. From a total of 500
questionnaires distributed, 132 usable questionnaires were returned, a response rate of 26.4%. The survey
was in two parts. The first part presented respondents with 14 statements regarding potential barriers to
entry. Respondents were asked to state their level of agreement with respect to the strength of each
potential barrier on a seven point Likert scale. The statements presented to respondents are listed in Table
1. The second section of the survey sought demographic data such as gender, age, number of pharmacies
owned, geographic location, store type and number of assistants in the pharmacy.
RESULTS
Qualitative Research
Results of the classification of entry barriers are presented in figure 1. There was agreement that two of
the possible barriers to entry; government policy and service differentiation have a significant effect in this
industry. In addition buyer switching costs, economies of scale, site availability and cost advantages
independent of scale were considered to endow some deterrent effect, albeit significantly less than the first
two factors. There was a minority view that product differentiation was to some extent a barrier to entry.
With respect to competitive retaliation, there was extreme disagreement, with respondents evenly divided
on whether this was a strong barrier to entry or alternatively irrelevant. The remaining two possible
barriers to entry proposed by Porter, product availability and capital costs, were unanimously considered
to be irrelevant in this industry.
1
2
Strength of
the barrier
High
Low
Key
External
Internal
Locus of Control
4. Economies of Scale
1. Government Policy
5. Cost adv independent of scale
2. Service Differentiation
6. Site availability
3. Buyer Switching Costs
7. Product Differentiation
Figure 1: Participants view of the strength and locus of control of barriers to entry - qualitative phase
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It was considered that the retail pharmacy industry exerted a significant degree of control over only two of
the possible barriers to entry, service differentiation and government policy. Notably these were the same
two factors which were considered to be effective barriers. A low to very low level of control was
perceived regarding all other factors, except competitive retaliation which imbued a strong degree of
disagreement amongst the respondents. Therefore this factor has not been included in the matrix below,
but was investigated in the quantitative component. Similarly, product access and capital costs are not
included, since they were considered to be non-existent barriers in this industry and therefore the question
of control was not considered to be relevant by respondents. Whilst the possibility must be considered that
the apparent correlation between the perception of strength of the barrier and perception of control is due
to respondent confusion, during the interviews it was clear that the respondents did understand the two
different concepts. Thus it can be concluded that the generally held view of the respondents is that the
industry has succeeded in manipulating those barriers to entry over which it does have control, whilst
placing less resources on those which are perceived to be external, that is outside their control.
With respect to Porter'
s three entry deterrent strategies, pharmacy has focused on structural barriers in
their successful maintenance of legislation protecting the industry from competitive entry. The second,
expected retaliation is by no means clear, with strongly conflicting views held by different respondents
regarding the effectiveness of this strategy. Further analysis is required on this issue. The third strategy,
reduction of the inducement to entry, does exist, but interestingly was not used intentionally. A small
number of pharmacies have changed their positioning to become discount, low service providers, thus
initiating price cutting within the industry. Whilst this was not done in order to decrease the attractiveness
of the industry to supermarkets, it has certainly decreased the profitability of the industry.
Most
respondents did not consider however that the profitability had been (or indeed could be) reduced to a
level which would deter supermarkets from entry.
Quantitative
Descriptive Statistics
A total of 132 valid surveys were returned, of which 78 respondents (59%) were male. 46 (35%)
respondents were less than 40 years, 68 (52%) were between 40 years and 59 years and 16 (13%) were
60 years or more. In terms of ownership status 69 (53%) of respondents owned a single pharmacy while
51 (39%) respondents owned multiple pharmacies. In terms of the number of shop assistants there was
wide variation. Of those who responded for one pharmacy, 12 respondents (9% of the total) had 1-2 shop
assistants, 41 (30%) employed 3-5 assistants, 24 (18%) had 6-10 assistants, and 30 participants (22%)
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employed more than 10 assistants. 15 respondents replied in terms of multiple pharmacies. 60 pharmacies
were reported, of which all but 2 employed five or less assistants.
Pharmacies were located across Australia, with 34 (26%) being located in NSW, 19 (14%) in Victoria 48
(36%) in Queensland, and less than 10 in each of SA WA Tasmania and the ACT.
Analysis
The first stage of analysis was to examine the frequency data to determine which factor(s) retail
pharmacies believed would be most effective in deterring or minimising the impact of the entry of
supermarkets into the industry. The results are presented below in table 1. The questionnaire invited
responses on a 7 point Likert scale, where 1 represented “strongly disagree” and 7 “represented strongly
agree”. 3 represented “neither agree nor disagree”.
Table 1: Mean, SD and Entry Barrier by question
Q
1
2
3
4
5
6
7
8
9
Statement
Supermarkets will not be able to match
the economies of scale of retail
pharmacy
Supermarkets will not be able to
provide the same level of professional
service that my pharmacy provides
Supermarkets will be incapable of
operating a pharmacy since it is
different to other retail operations
Customers will not leave my business
since they have a strong relationship
with us
Professional advice is more important
to my customers than the price savings
that supermarkets might offer
I expect that the current regulations
restricting pharmacy ownership will be
maintained over the next five years
I expect that the current regulations
restricting pharmacy ownership will be
maintained over the next ten years
Supermarkets sell junk food, cigarettes
and alcohol and therefore have no
credibility as health care providers.
This will prevent them succeeding in
pharmacy
Supermarkets are not good at managing
professional personnel, this will prevent
them succeeding in pharmacy
Relates to the entry barrier
Economy of scale
Mean
2.3
SD
1.615
Differentiation
5.81
1.644
Cost advantages independent of
scale
3.06
1.933
Buyer switching costs
3.77
1.596
Buyer switching costs
4.7
1.364
Government Regulation
5.48
1.379
Government Regulation
3.95
1.617
Differentiation
4.03
1.814
Cost advantage independent of
scale
3.79
1.649
8
10
11
12
13
14
If pharmacy reduced its margins before
the entry of the competitor it might stop
that entry
If pharmacy assistants had to be
accredited, that would make it too
difficult for supermarkets to enter
If pharmacy undertook a promotional
campaign reinforcing its position as a
key part of the system of health care
provision, this would prevent a
customer defecting to supermarket
I believe that overall the level of
professional service in retail pharmacy
is high
I believe that pharmacy can scare
supermarkets off with a threat of
retaliation
Lowering inducement to enter
2.36
1.457
Raising structural barriers
4.15
1.694
Differentiation
4.58
1.554
Differentiation
5.23
1.333
Threat of retaliation
2.89
1.950
All means were within 2 standard deviations of the midpoint. The questions which elicited the most
deviation from the midpoint were questions 2 (questioning the level of customer service that could be
provided by supermarkets), 6 (the belief that regulatory barriers would be maintained for the next 5 years),
and 13 (belief that the level of service in pharmacies is generally high. Thus the barriers to entry which
were perceived to be the strongest were related to supermarkets’ capacity to deliver the levels of service
required, the maintenance of regulatory barriers, and the levels of service demanded by customers (all of
which share an external locus of control, while the barriers perceived to be least effective include the
threat of retaliation and the possibility of pharmacy unilaterally reducing margins, both of which have
internal locus of control. These results are consistent with the qualitative phase of the research.
Each of the potential barriers were allocated to one of three groups depending on their locus of control.
Those that were clearly within the influence of the pharmacists (items 12, 11, 10, and 14) were grouped as
having an internal locus of control.
Those that were within the sphere of influence of either the
supermarkets (1, 2, 3, 8, and 9) or the government (items 6 and 7) were grouped as having an external
locus of control. Those that depended on the customer'
s perception of the pharmacy (items 4, 5, and 13)
and thus could be influenced, although not governed, by the pharmacist were grouped as having a locus of
control which was neither internal or external. This grouping, and the perceived strength of the barrier,
are reflected in figure 2.
9
Strength of
the barrier
High
2
6
8
9
7
3
13
5
12
11
4
10
Low
1
External
Internal
Locus of Control
Numbers relate to the statements recorded in Table 1
Figure 2: Strength of the barrier vs locus of control (quantitative phase)
The second stage of the analysis was to investigate whether the demographic factors influence the
perception of the strength (effectiveness) of a potential barrier. Independent samples t-tests were
undertaken. There was no significant difference based on gender with one exception. Agreement with the
proposition that the compulsory accreditation of retail pharmacy assistants would constitute a barrier to
entry was significantly (p<0.05) higher among female respondents. No other significant differences were
seen across any of the demographic variables.
DISCUSSION
Ideally, a barrier to entry should be both strong, and have an internal locus of control. In such cases
implementation of the barrier is not only possible, but is likely to be effective. In this case, however, the
majority of the potential entry barriers that were perceived by retail pharmacists as being likely to be
effective, are outside of their control. Strategically, therefore, the profession is in the hands of external
stakeholders in terms of its likely future attractiveness.
It is interesting to note that the views of the respondents in the qualitative phase regarding the locus of
control did not always accord with our views regarding where the locus of control lay. For example, the
respondents’ view was that government policy (in this case reflected by legislation preventing
supermarkets from entering the industry) had an internal locus of control.
This perhaps reflects
complacency generated by the historical success of the industry association (the Pharmacy Guild) in the
maintenance of the legislative barrier. Similarly, respondents in the qualitative phase felt that service
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differentiation was a barrier with a strong internal locus of control. Clearly, the level of service offered by
pharmacy does have an internal locus of control; however the pharmacists appear to ignore the fact that
differentiation exists in the mind of the customer and also depends on the level offered by the new market
entrant(s). We have, elsewhere, explored service quality as a competitive response in pharmacy (authors
2007). The piece of the puzzle which is missing, however, is the extent to which customers respond to
service levels within pharmacy. Much of pharmacy’s complacency rests on assumptions about the depth
of the relationship between pharmacy and its customer. This is, as yet untested empirically – and should
be a focus for future research. While it can be argued that the locus of control for this factor is internal, its
reception and validation depends on the customer, so the locus is shared.
No demographic differences were apparent in the analysis, except for one gender-based difference in
terms of the likely impact of compulsory accreditation of pharmacy assistants. It appears that the level of
complacency exhibited by members of the profession is shared across a range of demographic variables..
CONCLUSION
This study has raised several issues in terms of the development of an innovative extended framework and
the application of this framework to the classification of entry barriers in a specific industry. It has also
identified areas for future research, particularly in understanding the role of differentiation as a switching
cost (and therefore an entry barrier). The study reflects a level of complacency shared by members of an
industry under threat and their reliance on untested assumptions about both their future competitors, and
their current customers.
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