Entry

Contributed by: Anne Marie Knott




Introduction


Entry is important to strategy for two reasons. Offensively, entry is one of the most salient and prevalent strategic moves in the economy. New firms enter the economy at an annual rate of 10-12% of incumbents (entrepreneurial entry); existing firms enter new markets at about the same rate (Foster, Haltiwanger and Syverson 2008). Defensively, free entry should dissipate profits, so we want to understand the conditions under which firms can/should enter as well as the conditions under which incumbents can preclude entry. While both entrepreneurial entry and incumbent entry into new markets are related and important, because this is a strategy reader I focus on the latter.1

There are four basic questions regarding incumbent entry into new markets. These are when firms are driven to enter new markets, where (or which form of entry), whether to enter a particular market, and how to enter (entry mode). I treat the topics of when and whether in the main summary and leave the other topics for the appendix because they intersect topics elsewhere in the reader.

When firms are driven to enter new markets


The best foundational treatment of this question comes from Penrose (1959). There are essentially two answers: 1) firms facing negatively sloped demand curves inevitably exhaust growth in an existing market and therefore enter new markets to sustain growth; 2) firm capacity increases over time through learning curves and "receding managerial limits". These slack resources provide a stimulus (and means) to pursue new markets.

Helfat and Lieberman (2002) extend Penrose to look explictly at the relationship between resources and the when, where and how of entry. One of their main insights is that the Penrosian view of entry, where a firm's entry choices flows from its resources, is inconsistent with views such as Jovanovic (1982), where firms capability is only revealed post-entry. While true, it is worth noting two things. First, Jovanovic's model pertains to entrepreneurial choice between self-employment and wage employment where ex ante uncertainty is more likely. Second, even in the case of incumbent entry into new markets there is likely to be some uncertainty regarding the utility of the resources in the new setting.

Whether to enter (is entry viable?)


Most scholars when asked to define the "entry" literature would focus exclusively on whether. Before getting into the formal entry literature from Industrial Organization Economics (IO), it is worth mentioning that probably the canonical piece on corporate entry is Porter (1982). His five forces framework synthesizes much of the IO literature aimed at rooting out anti-competitive practices and inverts it as a guide for identifying attractive industries. Thus while it is nominally a book on competitive strategy, a major component is whether a market has profit potential, and thus is more valuable for those contemplating entry into a market than those already engaged in the market.

With that as an aside, the formal literature on entry isn't. As Kreps (1990:342) says when closing his discussion of entry in A Course on Microeconomic Theory: “In a sense there are not theories of entry, but theories of no-entry”. The goal of the entry literature is explaining why entry into markets ceases before profits are dissipated. Thus a better way to characterize the literature is one of entry barriers. The easiest way to navigate this literature is through survey pieces such as Gilbert (1989). However, the seminal piece in this literature is Stackelberg (1934) who derives permanent asymmetry in market shares (first mover advantage) in a duopoly where firm 1 chooses capacity before firm 2. This was followed much later by works proposing and modeling different entry barriers: limit pricing -pricing below the collusive monopoly price to dissuade entry (Bain 1949), sunk costs (Spence 1977, Dixit 1979), product proliferation (Schmalensee 1978), and economies of scale (Schmalensee 1981).

Most of this theory on entry barriers was motivated by salient examples. Thus an important companion literature is empirical tests of the theory. That work tends to find little support for the strategic use of entry barriers. Lieberman (1987) for example finds little evidence that excess capacity in the chemical industry is strategic, and Bresnahan and Reiss (1990) find that second entrants have the same costs and market opportunities as first entrants in 202 distinct markets.

One reason for the failure to find empirical support for entry deterrence is found in recent work proposing there is too much entry (Mankiw and Whinston 1986) and empirical support for that view (Berry and Waldfogel 1999).

Future directions for high quality research


There are problems with the entry barrier concept, thus there is potential to do high quality research that builds on prior work on entry. First, entry barriers don’t appear to dissuade entry. New firms enter the economy at a rate of 10-12% of incumbents per year and existing firms enter new markets at a comparable rate. We shouldn’t see this if entry barriers are effective.

Second, entry theory reveals an “entrepreneur’s paradox”: attractive industries are those with opportunity for sustainable profits. These are by definition are those which can’t be entered (because of entry barriers). If markets don’t have entry barriers, what assumptions allow firms to conclude there will be profits in equilibrium, which in turn cause them to enter?

Third, even ignoring entry barriers, the record on entry is dismal--60% of firms fail within 4 years. Why does entry persist? What does the entry decision function look like if it supports such seemingly irrational entry?
One approach we might take in reconciling all the above is to recondition entry theory—Rather than using it as a tool to examine the act of entry, offer it as a tool for examining viable entry. Some of the models lend themselves to this reapplication, but some do not (the models whose power comes from conditioning follower behavior, e.g., limit pricing).

As we retool entry theory, one question of interest is the extent to which the barriers are industry specific (demand, technology (minimum efficient scale-MES)) versus firm specific. Are entry barriers anything more than aggregated bases of competitive advantage for firms within the industry? To what extent do industry characteristics define the bases (exogenous entry barriers), versus the bases define the industry characteristics (endogeneous entry barriers). The high variance in entry rates across industries may help us understand this question.

What will be required to exploit this potential is closer alignment between entry theory and entry empirics. The international literature has contributed many of the stylized facts relating firm and market characteristics to entry decisions. This is because the international setting (like the chain setting) has a natural experiment quality—observing entry by the same firm in multiple markets and multiple firms in same market. What would help the “new theory of entry” is greater formalism in these empirics—more explicit characterization of the firm’s decision function. This supports more direct test of existing theory. Better empirical characterization of the firm’s decision function will in turn support more realistic formal modeling of firm strategic behavior and market outcomes.


Appendix


Bibliography




1 This forces me to exclude some nice models of entry: the evolutionary economics models of entry/exit/growth of new markets; models of entrepreneurial entry from the self-employment literature, and models of entrepreneurial spinoff from existing firms.