Chapter 16: Entry into New Businesses
Study Guide by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
Porter's Competitive Strategy Main Page
Chapter 16: Entry into New Businesses p. 339
Two forms of entry into a new business include acquisition, and internal development. The purpose of this chapter is to discuss how the tools of competitor analysis can help managers make entry decisions, recognizing that a sound, well managed entry is not sufficient to assure successful entry. The key is to find industries where the market forces are not working perfectly.
Entry through Internal Development p. 340
A firm entering a new business through internal development (internal entrant) must consider structural entry barriers and retaliation from existing firms in the industry. The expected cash flows from joining an industry must be balanced against the investment cost required, the additional investment needed to overcome structural entry barriers (Chapter 1), and the expected cost of retaliation from existing firms (e.g., lower prices, higher marketing costs). A new entrant might also create excess capacity in the industry, and motivate existing firms to add capacity if the new firm enters with more up-to-date equipment and facilities. The decision to enter through internal development must include forecasts of all of these costs and reactions by competitors.
Will Retaliation Occur? p. 342
An internal entrant is likely to provoke retaliation in certain types of industries:
Slow Growth - Slow-growing markets cannot quickly utilize the capacity added by a new entrant putting pressure on existing firms to retaliate.
Commodity or Commodity-like Products - In commodity type industries firms are not protected by brand loyalties or segmented markets, and are likely to move against a new entrant.
High Fixed Costs - Where there are high fixed cost in an industry, the capacity added by the new entrant will trigger retaliation if utilization of existing capacity declines significantly.
High Industry Concentration - Where there are only a few firms in an industry, a new entrant will have a significant effect on one or more existing firms who will be motivated to retaliate.
Incumbents Who Attach High Strategic Importance to their Position in the Business - Firms that rely on their position in an industry for cash flow, future growth, company image, or interrelationships with other company businesses are likely to retaliate.
Attitudes of Incumbent Management - Managers who have an emotional attachment to the business, or who have some other reason to view a new entrant with distain are likely to react vigorously against the new firm. (See Chapter 3).
Identifying Target Industries for Internal Entry p. 344
Industries that are stable or in equilibrium are not good candidates for entry unless the firm has a special advantage. Good targets for entry include industries: that are in disequilibrium, that include firms who are not expected to retaliate effectively, have a lower cost of entry for the firm than for other firms, where the firm has a distinctive ability to influence its structure, and where entry will provide positive effects on the firm's existing business.
Industries in Disequilibrium
New Industries - The structure of new industries is not well established and early entry may be appropriate based on some analytical techniques described earlier (See Chapter 10).
Rising Entry Barriers - Increasing entry barriers provides another reason to enter an industry early since these barriers will block later entrants.
Poor Information - Some obscure industries may have an imbalance between the cost of entry and potential profits, but other firms are also likely to become aware of this situation. Entering early and creating some barriers to imitation may provide a competitive advantage, although it will likely decline over time.
Slow or Ineffectual Retaliation
Incumbent's cost of effective retaliation outweighs the benefits - Some industries include firms that are unlikely to retaliate because they are not well informed are the cost of retaliation is greater than the perceived benefits.
There is a paternal dominant firm or tight group of longstanding leaders - An industry leader might not retaliate because they have never had to compete with new entrants before, or because they view their position as a protector of the industry (e.g., they maintain high prices, and customer service).
Incumbents' costs of responding are great given the need to protect their existing business - An existing firm might not retaliate because to do so would alienate existing distributors, hurt its key business in some way or be inconsistent with its image.
The entrant can exploit conventional wisdom - Existing firms may cling to outdated methods that new entrants with no preconceived notions can exploit.
Lower Entry Costs
Industries where the firm has a greater ability to overcome entry barriers than other firms because the firm has certain skills or assets (e.g., proprietary technology, established distribution channels, or brand name), or where retaliation by incumbent's would be less because the firm is viewed as fair and non-threatening.
Distinctive Ability to Influence Industry Structure
Industries where the firm can increase mobility barriers for subsequent entrants, e.g., in a fragmented market. See Chapter 9.
Positive Effect Existing Businesses
Industries where the firm's entrance improves its existing businesses in some way, e.g., company image, distribution channel relationships, helps defend against threats, etc.
Generic Concepts for Entry p. 349
These concepts involve various ways to overcome entry barriers more cheaply than other firms.
Reduce Product Costs - Some potential ways of reducing product costs include developing new process technology, building a larger plant to gain scale economies, and develop more up-to-date facilities.
Buy in with Low Price - Use lower prices to gain market share in cases where other firms are unwilling or unable to retaliate.
Offer a Superior Product, Broadly Defined - Offer a better product or service innovation.
Discover a New Niche - Enter and cater to an unrecognized market segment.
Introduce a Marketing Innovation - Use a new innovative marketing approach that overcomes barriers.
Use Piggybacked Distribution - Use established distribution channels and relationships.
Entry through Acquisition p. 350
The characteristics of entry through acquisition include:
Acquisition does not add a new firm to the industry.
The acquisition price is set in a well organized market for companies that includes finders, brokers, and investment bankers, in addition to buyers and sellers.
An efficient market tends to eliminate above-average profits resulting from an acquisition.
The expected present value of continuing to operate the company sets the floor price of an acquisition, and the price usually must exceed the floor to provide a premium to the owner for selling.
An acquisition is more likely to be profitable if certain conditions are present: The floor price is low, the market for companies is imperfect in that it does not eliminate above average returns through the bidding process, and the buyer has a unique ability to operate the acquisition.
The Height of the Floor Price p. 352
The floor price will be low in cases where the seller has estate problems, needs capital, has lost its key management with no successors, believes there are capital constraints to grow, or recognizes that the company has management weaknesses.
Imperfections in the Market for Companies p. 353
The term market imperfections refers to situations where the bidding process for a company will not eliminate the profits from an acquisition. Market imperfections occur in the following situations:
1. The buyer has superior information, e.g., knowledge about trends in technology.
2. The number of bidders is low because the seller is unusual or very large.
3. The condition of the economy is weak and few firms are willing or able to deal with the economic downturn.
4. The selling company is sick and most bidders are looking for sound companies.
5. The seller has non-economic objectives, e.g., how the seller's employees will be treated, whether the seller's management will be retained, and the owners' desire to associate their work with a prestigious company.
Unique Ability to Operate the Seller p. 354
The buyer can pay more than other bidders and still acquire a company profitability when:
1. The buyer has a distinctive ability to improve the operations of the seller because it has certain assets or skills that other bidders do not have.
2. The firm buys into an industry that meets the criteria that allows it to change the industry structure to its advantage in some way, e.g., exploit outdated methods supported by the conventional wisdom.
3. The acquisition will uniquely help a buyer's position in its existing business, e.g., provide a better distribution system, or facilitate entry into new markets.
Irrational Bidders p. 355
It is important to understand the goals and objectives of the other bidders since some bidders might continue to bid beyond the point where the acquisition would produce above-average profits. Bidders might raise the price above the acquisition's value because it will help the bidders current business, the bidder has a unique way of improving the target, or has growth as a primary objective.
Sequenced Entry p. 356
Entering an industry includes becoming part of a target strategic group (See Chapter 7). A sequential strategy involves an initial entry into one group (e.g., moderate line) and a subsequent move to another group, or to the ultimate target group (e.g., full line, vertically integrated). Sequenced entry can lower initial mobility barriers, and allow the firm to accumulate capital for subsequent shifts to another group. Analysis of sequenced entry is also useful for developing ways to prevent other firms from using a sequenced entry into the firm's own industry.
Appendix A: Portfolio Techniques in Competitor Analysis
Porter discusses the key elements of two portfolio analysis techniques: The growth/share matrix, and the position/industry attractiveness screen.
Appendix B: How to Conduct an Industry Analysis
A discussion related to collecting and analyzing two kinds of data about industries: Published data, and data gathered from interviews.
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Go to my Summary of Porter's 1987 HBR article From competitive advantage to corporate strategy, or back to Porter's Competitive Strategy Summaries Main Page.
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