What Are the Key Barriers to Entry in Electronics?

The electronics sector includes consumer electronics, specialized electronics for other industries, and component parts such as semiconductors. Barriers to entry are specific to each part of the sector. These barriers make it costly or cumbersome for new firms to enter the market and help shield established firms from competition. The presence of these barriers and the resulting lack of competition enable established firms to set higher prices, which limits demand.

Common barriers to entry include economies of scale and scope, research and development, capital-intensive production, switching costs, and brand loyalty.

Economies of Scale and Scope

Consumer electronics with mass popularity are more susceptible to economies of scale and scope as barriers. Economies of scale mean that an established company can easily produce and distribute a few more units of existing products cheaply because overhead costs, such as management and real estate, are spread over a large number of units. A small firm attempting to produce these same few units must divide overhead costs by its relatively small number of units, making each unit very costly to produce.

Similarly, economies of scope give established firms an advantage because they can use their existing machines and facilities to launch new products. If Apple (AAPL), for example, wanted to launch a new device, the company could use its existing marketing staff, factories, and other facilities to support the launch. Any variable costs associated with Apple's new product launch would be the same variable costs new firms face, but the overall cost per unit to Apple would be lower since the new firm would be required to take on the fixed costs of salaried staff and leased space.

Research and Development (R&D) and Capital-Intensive Production

Research and development (R&D) and capital-intensive production are more typically the barriers to entry in the field of semiconductors and non-consumer electronics. While consumers may accept generic and simple electronics, businesses demand electronics that are specialized in their industries, requiring more intensive research and development.

Existing semiconductor firms have invested billions of dollars in developing patents and acquiring cutting-edge technology. New firms are forced to either license processes and technology from established firms or tie up capital in an attempt to match established firms' capabilities.

High Switching Costs and Brand Loyalty

In the electronics industry as a whole, high customer switching costs and brand loyalty are common barriers to entry. Naturally, occurring switching costs include the difficulty of learning to use a new company's products and installing new electronics in a company or home.

Established electronics companies may strategically build in switching costs to retain customers. These strategies may include contracts that are costly and complicated to terminate or software and data storage that cannot be transferred to new electronic devices. This is prevalent in the smartphone industry, wherein consumers may pay termination fees and face the cost of reacquiring applications when they consider switching phone service providers.

As in many other industries, brand loyalty keeps buyers coming back to a company with which they have positive associations, and new firms must invest heavily to match years of advertising and user experience.

The Bottom Line

Barriers to entry exist in every sector and the electronics sector has many, primarily the high costs associated with research and development and brand loyalty. Though these barriers exist, improved costs and widely available knowledge has brought these barriers to entry down in the last few years.