Starting, running or growing a business can require the acquisition and utilisation of a wide range of resources and capabilities and typically involves a huge degree of risk. Consequently, the reality is that many new businesses fail. 

Barriers to entry may reduce the chances of a business successfully starting up or entering a new market. Such barriers include: financial barriers; complicated or restrictive regulation (for instance certain jurisdictions may not allow foreign businesses to enter particular local markets); an inability to compete against established competitors; various risks and uncertainties; and a lack of resources.

Barriers to entry: this refers to the obstacles (such as costs, expertise and relationships) that make it difficult for new businesses to enter a particular industry or area of business.

Costs

The primary aim of most businesses is to generate profit. To do this, a business’ revenue (turnover) must exceed its fixed costs and variable costs. Profits increase as costs decrease or revenue increases. Therefore, keeping costs as low as possible is essential if a business is to maximise its profit margins.

Profit margin: the amount of profit generated per item after deducting the average cost of producing each item.

Revenue / turnover / sales: the total income generated from a firm’s operations within a period of time. This does not take into account costs, instead purely reflecting the money that has been received from consumer sales. For example, if a company sells 10 handbooks for £10 each, its revenue would be £100.

Fixed costs: business costs that remain the same regardless of the number of units produced or sold. Examples include: the rent paid for an office or a factory; the cost of paying utility bills; or the cost of fuel for an aeroplane flight. These costs will all remain the same (or almost the same) regardless of whether a company sells 0 or 1000 units.

Variable costs: costs that change in relation to the number of units produced or sold, for instance the cost of packaging or delivering each individual product. Labour to some extent is a variable cost as over time, the number of employees may change to reflect a company’s level of output. However, in the short term, labour is generally a fixed cost.

There are various strategies that businesses can employ to minimise or stabilise costs. For instance: maximising economies of scale; integrating into the supply chain; outsourcing; offshoring; entering into long-term contracts; and utilising derivatives.

Economies of scale: this refers to the cost advantage that arises when fixed costs remain the same but production or output (e.g. the size of an order) increases, and/or where costs decrease because output has increased. For example, the cost of professionally printing 100 handbooks is much higher per handbook than if I were to print 2,000 handbooks in one go, as in the latter case, the fixed costs of setting up the print job would be spread across more units. In such circumstances, the supplier is usually willing to pass on a proportion of these cost savings, in turn reducing my input costs. Moreover, suppliers might also be willing to make less profit per unit if more units are ordered; this incentivises customers to spend more overall, in the knowledge that doing so will reduce the cost of each unit (thus enabling them to achieve economies of scale). When retailers offer deals such as “buy two, get one free”, this is essentially what’s happening; you, the customer, are being offered the opportunity to benefit from economies of scale if you are willing to buy more units in the first place.

Integrate into the supply chain: the supply chain is comprised of contributors involved in the process leading up to the sale of a product to the end consumer. For example, a supply chain for a particular product might include the supplier of raw materials, the manufacturer, the distributor and the retailer). Typically, each contributor will charge prices that include a profit margin, so if a business takes control of multiple stages in the supply chain (e.g. by acquiring one of its suppliers), it will not have to pay this additional margin, meaning its costs should consequently decrease (although it will of course need to cover the initial cost of acquiring the supplier).

Outsourcing: this involves a business contracting out various roles or processes to external companies (i.e. hiring third parties to deliver specific services rather than hiring employees to perform those services in-house). For example, a business might outsource its manufacturing needs to a company that specialises in manufacturing, or outsource its marketing needs to a marketing agency. Outsourcing can help companies to cut costs (for example, if they outsource to companies in jurisdictions where wages/costs are generally lower), benefit from expertise that isn’t available in-house, and access flexible staffing options (it may well be easier to stop working with a third-party company's staff than it would be to make employees redundant).

Offshoring: this involves shifting elements of production, distribution or other business processes abroad, usually to countries in which costs (e.g. labour) are lower. For example, many companies “offshore” manufacturing, software development and customer services.

Long-term contracts: entering into longer-term contracts can enable companies to control/more accurately predict future costs, or to mitigate the risk of price increases if, for instance, the price of raw materials increases globally. Participants in the supply chain may also provide more favourable rates to businesses willing to commit to longer-term relationships.

Derivatives: these are financial contracts relating to underlying assets (such as securities or commodities). Once example of a derivative contract is a “futures” agreement, which involves parties agreeing to engage in a transaction on a predetermined future date at a specified price. Another example is an “options” agreement, which gives one party the right (but does not obligate them) to purchase or sell a product on a predetermined future date at a specified price. Derivatives such as these can help companies to better predict future costs and mitigate the risk of future adverse price movements reducing profitability (this is known as “hedging risk”), which can facilitate more accurate financial planning.

Securities: this refers to tradable financial instruments that are generally used to raise capital in the public and private markets. Key examples include shares and bonds. Remember not to confuse “securities” with the type of security that might be granted by borrowers in connection with loan agreements (covered earlier in this handbook).

Commodities: this refers to basic goods that are essentially the same regardless of which company produces them, for example gold, oil and grain (commodities are often used as part of the production process for other goods and services). Investors can buy and sell commodities through stock exchanges, with buyers either seeking short-term delivery, or using derivatives such as futures or options to secure delivery in the longer-term.

Entering a saturated or highly competitive market

If there are existing competitors in the market that are more established, it may be difficult for new businesses to compete. Established businesses may benefit from having more recognisable brands and trusted relationships with consumers, and the consequent customer loyalty may prevent customers from switching to a product or service offered by a new market entrant.

Established businesses are also more likely to receive preferential rates from supply chain participants such as suppliers, reducing costs to a level that new businesses would struggle to match (having had little or no opportunity to earn good will or trust). In addition, an established business may benefit from economies of scale, enabling superior cost control and wider profit margins than that which a new entrant may be able to attain. Consequently, established firms may be able to undercut prices charged by new entrants.

To compete in saturated markets (meaning markets with many competitors), new firms may thus require a unique selling point. Firms could offer a product or service with unique attributes that differentiate that product or service from competitors’, or find a way to significantly undercut competitor prices (as Ryanair did in the airline industry). Such unique selling points could provide new entrants with a competitive advantage, resulting in a greater chance of success.

Uncertainty

If businesses produce new products, uncertainties arise as to whether there will be sufficient demand for those products to generate profit. Conducting extensive market research before fully investing in the design, production, distribution and marketing of products can mitigate this risk, enabling businesses to modify and adapt offerings to suit consumer preferences.

Resources and capabilities

Does the company have human resources with the necessary capabilities (skills, experience and expertise) to create, brand, distribute and market a viable product or service? Does the business have the necessary physical resources to successfully operate, most notably start-up capital, cash for operations, machinery and offices? 

A business lacking the necessary capabilities and resources could consider partnering with other businesses or employing people who have: relevant business experience, a network of beneficial contacts (which could facilitate the financing, production and distribution processes), knowledge of the target market, or the resources required to effectively operate. For example, small businesses could share resources such as office space, whilst start-ups could partner with individual investors willing to provide capital and other relevant resources in exchange for equity. Such investors are typically known as business angels.