The Threat of New Entrants

The threat of new entrants measures how easily new competitors can enter an industry and take market share from incumbents. When this threat is low, existing companies can raise prices, invest in growth, and earn high returns without worrying about new competition flooding in. When this threat is high, incumbent companies must price aggressively and invest defensively just to maintain their position.

Understanding barriers to entry is one of the most powerful tools in fundamental analysis. It tells you whether a company's competitive advantage is defensible or temporary. It tells you whether a profitable industry will stay profitable or be disrupted by new entrants. It tells you whether to sleep soundly or watch your back.

Quick definition

Threat of new entrants refers to the ease with which new competitors can enter an industry and take market share. It depends primarily on barriers to entry—the obstacles that existing companies have that new entrants lack. High barriers mean low threat of new entrants. Low barriers mean high threat.

Key takeaways

• Barriers to entry are the structural advantages incumbents have that make it expensive, difficult, or impossible for new entrants to compete on equal footing.
• The main barriers are capital requirements, scale economies, switching costs, brand and customer loyalty, access to distribution, proprietary technology and patents, and regulatory barriers.
• An industry with high barriers (pharmaceuticals, banking, semiconductors) can maintain high profitability for decades because new competitors can't easily enter.
• An industry with low barriers (apps, e-commerce, consulting) sees constant new entry and competition, which compresses margins and limits profitability.
• Entry barriers are not permanent. Technology shifts, regulation changes, and new business models can lower barriers, allowing disruption of incumbent-dominated industries.
• The strongest entry barriers combine multiple sources (e.g., patents + brand + switching costs + scale economies), making entry nearly impossible.
• Investors should focus on companies with defensible entry barriers; companies in industries with low barriers are vulnerable to disruption.

The main barriers to entry

Entry barriers come in several forms. The stronger and more numerous the barriers, the lower the threat of new entrants. Let me walk through the key ones.

1. Capital requirements

Some industries require massive upfront investment before generating a single dollar of revenue. The bigger the capital requirement, the bigger the barrier.

High capital barriers:

• Semiconductors: Building a foundry costs $10-20+ billion. Only a handful of companies worldwide can afford this (TSMC, Samsung, Intel). New entrants can't compete.
• Oil and gas refining: A refinery costs $5-10 billion to build. New competitors can't afford to enter.
• Telecommunications: Building a cellular network costs $5-20 billion depending on geography. Most countries have 2-3 telecom companies because only a few can afford the capital.
• Pharmaceuticals: Developing and bringing a drug to market costs $1-3 billion and takes 10-15 years. Generic entrants can copy, but creating novel drugs requires massive capital.
• Airlines: A major airline needs billions in aircraft, gates, and infrastructure. This limits new entrants to well-capitalized companies.

Low capital barriers:

• Software and apps: Building software can cost millions (not billions), and the cost has fallen dramatically. Thousands of app companies are started annually.
• Consulting: Starting a consulting firm requires office space and some smart people. Capital barriers are minimal.
• E-commerce: Starting an online store requires minimal capital (web server, inventory, advertising).
• Restaurants and retail: You need to build out a location, but capital is modest compared to manufacturing.

2. Economies of scale

Scale economies mean that the larger a company, the lower its per-unit costs. This is a barrier because a new entrant has to start small (and thus has high per-unit costs) while incumbents have large scale (and thus low per-unit costs).

Industries with strong scale economies:

• Cloud computing: Amazon, Microsoft, and Google have data centers worldwide and massive customer bases, which let them spread fixed costs across billions of dollars of revenue. A new cloud entrant would have to build data centers in all regions before getting any customer, making entry prohibitively expensive.
• Telecommunications: A telecom network has massive fixed costs (infrastructure, spectrum, towers). One incumbent can spread these costs across millions of customers cheaply. A new entrant would have high costs until reaching massive scale.
• Retail and distribution: Large retailers (Walmart, Amazon) have scale economies in logistics, purchasing power, and marketing. A new retailer starting small has high per-unit costs that incumbents don't have.

Industries with weak scale economies:

• Professional services (law, accounting, consulting): A 50-person firm can have similar per-unit costs as a 500-person firm. Scale helps, but doesn't create a moat.
• Luxury goods: A small luxury brand can have economics as good as or better than a large brand. Scale is not necessary.
• Software: Once a software product is built, per-unit costs are zero (software can be copied infinitely). Scale helps with marketing and R&D, but not with marginal unit costs.

3. Switching costs

Switching costs are the expenses or inconvenience a customer incurs when switching from one supplier to another. High switching costs lock customers in and make entry difficult.

High switching costs:

• Enterprise software: If a company has trained 1,000 employees on Salesforce and integrated it with all of its other systems, switching to a new CRM is expensive and disruptive. This lock-in lets Salesforce raise prices and makes entry difficult for competitors.
• Operating systems: A computer user with 10 years of files, settings, and programs on Windows would lose productivity switching to Mac. This lock-in has protected Windows despite competition from Mac and Linux.
• Credit card networks: Merchants accept Visa and Mastercard because their customers expect them. Switching to a new card network would require coordination of all merchants, which is difficult. This makes competing with Visa and Mastercard very hard.
• Medical devices: Hospitals train surgeons on specific equipment. Switching to a new system requires retraining, changing protocols, and potentially losing expertise. This lock-in lets device makers maintain pricing power.

Low switching costs:

• Gas stations: A customer will switch to a different station for a 2-cent-per-gallon price difference. There's no switching cost. This is why gas station pricing is so competitive.
• Supermarkets: A customer will shop at a different supermarket for better prices or selection. There's no switching cost.
• Streaming services: A customer can cancel Netflix and subscribe to Disney+ or Amazon Prime. Switching costs are zero (just stop paying and start paying elsewhere).

4. Brand loyalty and customer loyalty

A strong brand can make customers loyal to the point where they resist switching to competitors, even if competitors offer similar products at lower prices. This loyalty makes entry difficult.

Strong brand loyalty:

• Luxury goods: Louis Vuitton, Hermès, Rolex have fanatical customer loyalty. The brand is the product. New entrants struggle because customers want the brand, not just the product.
• Consumer staples: Coca-Cola has brand loyalty that transcends the product. A similar cola from a new entrant would struggle to gain shelf space and customer adoption.
• Fast food: McDonald's, Chipotle, Starbucks have loyal customers. New entrants struggle to overcome brand presence and loyalty.
• Pharmaceuticals: A branded drug has customer loyalty (both doctors and patients know the drug). Generic competitors can enter after patent expiry, but the brand advantage persists for years.

Weak brand loyalty:

• Commodities (oil, wheat, metals, minerals): There's no brand. Customers buy based on price and quality, not brand. New entrants can compete immediately.
• Gasoline: Despite brand names (Shell, Chevron, BP), customers choose based on price and location. Brand loyalty is weak.
• Basic manufacturing: Commoditized parts and materials have weak brand loyalty. Customers are indifferent between suppliers as long as quality and price are similar.

5. Access to distribution

Distribution channels are the routes to customers. If a new entrant can't access distribution, it can't sell, regardless of product quality. This is a barrier.

Restricted distribution:

• Retail shelf space: Getting products into Walmart, Target, or supermarket chains is hard. These retailers have limited shelf space and incumbent products already occupy the best spots. A new product must convince retailers to drop something else and take a chance on the new product.
• Medical device distribution: Medical devices are sold through hospitals and clinics, which have established relationships with suppliers. A new device manufacturer must convince hospitals to switch, which is hard.
• Pharmaceutical distribution: Drugs are sold through pharmacies and doctors. Established relationships and physician habits create a barrier.
• Auto parts: Cars parts are sold through dealers, distributors, and retailers. Established relationships create barriers for new parts suppliers.

Open distribution:

• E-commerce and direct-to-consumer: Companies can reach customers directly online, bypassing traditional distribution channels. Amazon lets anyone sell, creating no barrier.
• Digital services: Software can be distributed online (app stores, websites) with no gatekeepers. This lowered barriers for app makers.
• Streaming: Content creators can reach consumers through YouTube, podcasts, and streaming platforms. Traditional gatekeepers (studios, networks) have less control.

6. Proprietary technology and intellectual property

Patents, trade secrets, and proprietary technology can create entry barriers by preventing new entrants from using the same technology.

Strong IP barriers:

• Pharmaceuticals: Patents on drugs create 20-year protection (sometimes extended through regulatory strategies). Competitors can't make the drug until the patent expires. This creates a moat for branded drugmakers.
• Semiconductors: Chip design requires advanced technology, and successful chip designers often have intellectual property (architecture, designs) that new entrants can't easily replicate.
• Software: Some software companies have unique algorithms or architectural advantages that competitors can't easily duplicate. Google's search algorithm, for example, is difficult to replicate.
• Manufacturing: Some manufacturing processes are proprietary and give cost or quality advantages that new entrants can't match.

Weak IP barriers:

• Open-source software: Code is freely available. New entrants can build on it. IP is a weak barrier.
• Basic manufacturing: If a process or product is straightforward and doesn't require patents, competitors can copy easily.
• Fashion: Designs can be copied (and often are by fast-fashion retailers). IP protection is weak.

7. Regulatory barriers

Government regulation can prevent or slow new entrants.

Strong regulatory barriers:

• Banking: Banks require licenses, capital requirements, and extensive regulation. This limits new entrants and protects incumbent banks.
• Insurance: Insurers need licenses and capital. Regulation is heavy. New entrants are rare.
• Utilities: Most utilities are regulated monopolies or oligopolies. Competition is restricted by regulation. New entrants can't legally compete in most areas.
• Pharmaceuticals: Drugs must be approved by regulators (FDA in the US), which takes years and costs billions. This slows generics and new competitors.
• Telecommunications: Spectrum is licensed by government. New telecom entrants need government permission and expensive spectrum purchases.
• Alcohol and tobacco: Heavy regulation and taxation create barriers for new entrants.

Weak regulatory barriers:

• E-commerce: Minimal regulation. New online stores can launch easily.
• Software: Minimal regulation. New software companies launch constantly.
• Consulting and professional services: Regulation exists (licensing for lawyers, accountants) but is not prohibitive to new entry.

How to assess new entrant threat in practice

When analyzing an industry, ask these questions:

1. Capital: How much upfront capital is required to compete? Can a new entrant raise it? Is capital scarce or plentiful?

2. Scale: Do I have to be large to be profitable? Can a small new entrant be profitable? Or does scale give incumbents such an advantage that new entrants are forced to start very small (and thus have high costs)?

3. Switching costs: How expensive or difficult is it for customers to switch to a new entrant? Are there contracts that lock customers in?

4. Brand: How important is brand to customer choice? Can new entrants build brand quickly, or is brand built over decades?

5. Distribution: Can new entrants access customers directly, or are they locked out by incumbent relationships?

6. Technology: Are there proprietary technologies or patents that incumbents own? Can new entrants use similar technologies?

7. Regulation: Does regulation restrict entry? Can new entrants get licenses or approvals easily?

If the answer to most of these is "high barriers," then the threat of new entrants is low, and incumbent profitability is protected. If the answers suggest low barriers, then new entrant threat is high, and incumbent profitability is vulnerable.

Real-world examples: high vs low new entrant threat

Low threat of new entrants (high barriers):

• Pharmaceuticals: Patents create 20-year protection for approved drugs. New entrants must spend billions and wait 10-15 years to develop a drug. Only a few companies have the capital and expertise. Result: Incumbent drugmakers are protected from new entry for decades.
• Semiconductor manufacturing: Building a modern foundry (fab) costs $10-20 billion. Only TSMC, Samsung, Intel, and a few others can afford this. New entrants can't compete. Result: Semiconductor manufacturing is dominated by a few players.
• Telecommunications: Building a cellular network requires billions in spectrum, towers, and infrastructure. Government restricts spectrum (creating regulatory barriers). Only a few players per country can afford entry. Result: Oligopolistic markets with 2-4 major players.

High threat of new entrants (low barriers):

• E-commerce: Capital barriers are low (rent a warehouse, set up a website, buy inventory). No patents protect incumbents. Customers can easily switch. Thousands of new retailers enter annually. Result: Intense competition, compressed margins, constant disruption.
• Software and apps: Capital barriers are low (buy a server, write code). No patents protect the basic functionality. Customers can switch (uninstall and download a new app). Result: Thousands of new apps enter the market annually. Survival is hard.
• Consulting and professional services: Capital barriers are minimal (hire smart people). No patents. Customers can easily switch to a new firm. Result: Thousands of new consulting firms start every year. Competition is intense.

Entry threats can emerge quickly

Entry barriers can crumble when technology shifts. Consider cameras. For 100 years, Kodak, Canon, and Nikon dominated because they had brands, distribution, manufacturing expertise, and patents. Then smartphones emerged with powerful cameras built in. The barrier to entry for photo-taking was demolished. Millions of people stopped buying cameras. The incumbents' moat disappeared.

This is why you should always ask: "Is this barrier likely to erode in the next 5-10 years?" Technology disruption, new business models, regulatory changes, and changing customer preferences can all lower barriers rapidly.

FAQ

Q: Can a company with low entry barriers still be a good investment? A: Yes, if it's the cost leader or has other advantages (strong brand, customer loyalty, switching costs) that let it compete despite low barriers. But a company in an industry with low barriers is more vulnerable. You should demand a lower valuation to compensate for the risk.

Q: What's the difference between threat of new entrants and rivalry? A: Rivalry is competition among existing players. Threat of new entrants is the danger of new competitors entering. They're different forces. An industry can have weak rivalry (few competitors, not fighting hard) but high new entrant threat (low barriers).

Q: Do entry barriers last forever? A: No. Barriers can erode due to technology, regulation, or business model innovation. A barrier that lasts 20 years might be disrupted in the next 10. That's why you always ask: "How durable is this barrier?"

Q: How do I know if a new entrant is a real threat? A: Look at track record. Have new entrants succeeded before in this industry? Are there signs that a new entrant (a startup, a foreign company, a company from another industry) is preparing to enter? Is something changing (technology, regulation, customer preference) that would lower barriers?

Q: Can a company create barriers to entry that don't exist naturally? A: Yes. A company can create switching costs by integrating with customer systems, build brand loyalty through quality and service, invest in proprietary technology and patents, or secure distribution relationships. These are company-level barriers, not industry barriers. The difference matters: industry barriers protect all incumbents; company barriers protect only that company.

Related concepts

• Competitive moats — The durable advantages that let a company defend its market position
• Disruptive innovation — How new entrants with new technologies or business models can bypass entry barriers
• Incumbents and disruption vulnerability — Why incumbent companies are often caught off guard by entrants using new models
• Cost of entry and market entry strategies — The financial and strategic costs of entering a new industry
• First-mover advantage — Whether being first to enter creates barriers that protect against later entrants

Summary

The threat of new entrants is one of the five forces that determine industry attractiveness. It depends on the height and durability of barriers to entry: capital requirements, scale economies, switching costs, brand loyalty, distribution access, intellectual property, and regulation.

Industries with high barriers (pharmaceuticals, semiconductors, banking, telecommunications) are protected from new entry and allow incumbent companies to maintain high profitability for decades. Industries with low barriers (e-commerce, apps, consulting) see constant new entry, which compresses margins and limits incumbents' ability to earn high returns.

As a fundamental analyst, your job is to assess whether the barriers protecting a company's market position are durable or vulnerable to disruption. A great company in an industry with eroding barriers can still underperform. A mediocre company in an industry with high, durable barriers can still outperform. Understand the barriers, and you understand the competitive landscape.

Next

Read the next article: Bargaining power of suppliers.