How can cost advantage be used as a barrier to entry?

Home, - What it means for a firm to have cost advantage over its competitors

Question: Briefly explain what it means for a firm to have cost advantage over its competitors, and what are the economic conditions conducive to it.

Cost advantage is that benefit to an organisation where it can cause production of its goods or services at a price that is cheaper than its peer competitors. This allows such business organisations to sell and produce in increased quantities than its competitors within the industry. Any organisation can capitalise it's cost advantages in either of the two methods described as under-

1. Business organisations can decide to quote the price of the offerings at the same level as its competitors but make increased profits due to lower cost of production.         

2.  Such business firms can on the contrary lower the selling prices comparatively to their competitors to gain market share within the industry and cause increased sales turnover. The loss incurred due to lower selling price is offset by the increased profit made by the entity on increased production and sales output

Any company that can reap cost benefit is definitely creating competitive advantage for itself as well. This competitive advantage can take the form of either offer advantage or niche advantage or a combination of work. It would help such business organisation to maintain a strong foothold within the industry and attract new customer base thereby improving its profitability quotient.

The following conditions result in a more conducive cost advantage situation for the firm-

1.  The company should have access to raw materials that are low in cost than its competitors

2.       It should have inbuilt updated technological setup and instill such operational processes that are highly efficient and effective to accelerate production capacity and lower down direct production cost

3.       The organisation should be lower distribution, marketing and sales expenditure than its competitive firms within the industry

4.       The firm should also efficiently manage all its business operations that are directly or indirectly associated with production management 

How can cost advantage be used as a barrier to entry?

There are several barriers to entry that can restrict new entrants from entering the industry. some of the major barriers include cost advantage, economies of scale, government policy, lower production costs, etc. Here, we shall discuss advantage can cause barriers to entry for new entrants in the industry. Cost advantage as described above exists when unit cost for producing a gold is relatively higher for new entrants than those already investing in the market. This would cause them to either raise their selling prices in order to obtain required profits or reduce their profit margins. In both the situations, New entrant organisation is likely to facelosses either due to decline in expected profits or decline in expected sales. Cost absolute advantages can be obtained by lowering production cost, obtaining water supplies at strategic prices, aviation production techniques and through lower interest costs. These would allow the new Entrant firms to face stiff competition from the existing players within the industry and also face resistance from the market segment. Hence, it can be said that cost advantages both absolute and relative can cause barrier to entry and would allow the management of potential entrants to rethink their decision viability, feasibility and Sustainability of the business.   

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