Entry Barriers and Non-Price Aspects of Firms' Behavior

Abstract

THE conventional theory of entry barriers focuses upon the price and output policies of established firms as a determinant of potential entrants' behavior. According to this body of analysis, advertising can affect entry barriers by influencing firms' cost conditions, either causing scale economies or, if entrants must advertise more than established firms in order to achieve any given level of sales, by creating absolute cost differences between established firms and entrants. This approach to the influence of advertising on entry barriers is incomplete, for several related reasons. Although a situation in which entrants must advertise more than established firms may legitimately be treated in terms of an absolute cost disadvantage for entrant firms, conventional entry barrier theory does not explain what determines the optimal advertising level of established firms and entrants, or the circumstances in which entrants will have higher advertising costs per unit of sales than established firms. A particular level of advertising by entrants and established firms is obviously implicit in all the conventional analyses of entry barriers, since both the market demand and demand for an entrant's product will depend on the level of advertising expenditures of established firms and the entrant. The general assumption that advertising outlays per unit of sales will be higher for entrants than for established firms does not necessarily follow, however, even when established firms' advertising is more effective than that of entrants. It is essential that the determinants of firms' advertising be explicitly integrated into the theory of entry, since the optimal pricing and advertising policies of any firm are interrelated. Section I below summarizes the current state of entry barrier theory and provides an analytical framework for the subsequent extension of the theory to incorporate advertising entry barriers. Section II considers the implications of advertising for a potential entrant's behavior, examining the circumstances in which it is possible for established firms to deter entry by appropriate advertising behavior, and whether it will be optimal for them to do so. Section III considers the relevant empirical evidence pertaining to the relationship between advertising and entry barriers. Although the relationship between advertising and entry barriers is stressed in this paper, the analysis and conclusions apply equally to any type of expenditure which affects the demand conditions for a firm's product.