Experience is the best teacher.
So while my first introduction to the idea of barriers to entry was undoubtedly as an undergrad, my first encounter with them was six months into my first post-college job.
I was working as an assistant project manager in a technology start-up for eight months. It was much more than a ramshackle operation, as one might imagine in someone’s garage – even though some of the biggest companies of all time began like this. We had around 40 employees and had obtained tens of millions of financing. I mention these facts only to establish that it is not just parents who fail at the barriers to entry that I will describe.
The notion of barriers to entry is a concept subject to much confusion, although it is not necessary. Start by making two distinctions. There are barriers that appear “naturally”, so to speak, in the markets. Then there are those created by government activity. Among these, the barriers take the form of special government privileges – sometimes “direct”, sometimes “indirect”. More on that in a moment.
“Natural” barriers to entry include things like brand loyalty or economies of scale that make it more expensive for a new entrant to compete with incumbents. There is nothing “special” about “natural” barriers. They arise when a seller is particularly effective in satisfying consumer preferences. They exist the same way Novak Djokovic’s tennis skills are a barrier to entry for former Division III tennis players, like me, moving up the world rankings. The barriers that appear naturally in the markets demonstrate the presence of healthy and competent competitors in the market. Market entry may be “prohibited” in some sense, but costs are a barrier to all stock. Natural barriers to entry are only a special case of this general principle.
Government barriers to entry are “artificial” in the sense that they do not arise from a producer’s superior productive efficiency. Direct grants of special privileges are easy to detect. Internet service providers are a classic example. Municipal governments usually distribute licenses that limit the number of ISPs in a region. The government intentionally and directly grants entry to some businesses and prohibits others.
By contrast, indirect grants of special privileges are a little harder to see, but they are probably all the more ubiquitous. Two quick examples. The Americans with Disabilities Act required (among other things) that companies install disabled-accessible cubicles in their washrooms. Wal-Mart easily swallows the costs associated with this requirement. Expanding restrooms by a few feet is a drop in the bucket as a percentage of their total real estate costs. However, moms and pops may find that their costs have increased by ten percent. This ADA stipulation disproportionately hurts small businesses. Indirectly, the government gave special rights to Wal-Mart.
This brings me back to my own crude encounter with indirect grants of special privileges. I was re-reading an email for the fifth time, making sure I had grasped its concise content. For 6 months, I have been helping our startup to comply with the Children’s Online Privacy Protection Act (COPA). I meticulously took screenshots of every page on our site and sent them to a group of digital compliance lawyers. They would respond with requirements and recommendations that I would communicate to our developers.
As with so many other indirect barriers to entry, COPPA apparently has the best intentions: to protect children under 13 when using the Internet. COPPA may achieve its goal, but I am no expert.
What I have learned with complete clarity, however, is that even the best-intentioned public policy has ripple effects that policy makers are not always able to anticipate. I was (re)reading the email from our DC-based legal counsel. The very nice lawyer I had corresponded with was reluctant to inform me that Congress had just passed a major overhaul of COPPA. Our hard work over the past six months has been in vain. We would start again.
Except we never did.
At that point, our CEO decided that we were simply not going to enter the 13 and under market. This decision was particularly ironic because I have never come across a digital product that would have been safer for children than the one we offered. Privacy and security were the distinguishing features of our product. Nevertheless, the high cost of compliance barred our entry. By regrouping, the CEO announced that we “could” serve this market segment later, when we are bigger and have more resources.
My six months toil was swept away in an instant. The hard work of a dozen developers was also in vain. And it would be easy to focus on that “wasted” work, but mistakes – mistakes – happen all the time in markets and in life. They are essential. No, here the true the cost was that the so called tech giants lived to see another day as a cocky upstart with the aim of nipping at their heels was kicked out by the visible government
How long did it take (say) for Facebook to comply with the new COPPA regulations? If I had to guess, I’d say two hours. Within seconds of the amendments being passed by Congress, Facebook management was undoubtedly aware of these developments. Facebook’s large in-house legal team quickly spoke with a few of its world-class engineers, who summarily made the necessary changes.
Even before the malaise generated by the cocktail of covid, covid politics and money printing, it was well recognized that the US economy had grown increasingly sclera. While a spot in the grand scheme of things, it is a trend that invites more urgent research, as a consensus on its causes does not seem to be emerging. Research must reveal how much of the declining dynamism of the US economy is due to a proliferation of indirect grants of special privileges.
What I do know, however, without any sophisticated econometrics, is that my own encounter with indirect grants of special privileges is not one I wish to repeat anytime soon – or ever.