Entering New Markets: Barriers for Penny Stock Companies - dummies

Entering New Markets: Barriers for Penny Stock Companies

By Peter Leeds

The more difficult it is for a penny stock company to enter an industry or market, the greater the barriers to entry. These barriers can make it impossible for some companies to start operations in a certain space, but they also can help companies already selling to that market because they reduce the likelihood of new competition arising.

Imagine if you are running a weight-loss website. You could have a dozen new competitors today alone because it would be very simple for them to get up and running.

On the other hand, a nuclear power plant construction firm will likely see very few competitors enter the market. Due to the high barriers of entry, which include technical knowledge requirements, expenses, and regulations, the industry may never see a new competitor enter the market.

Many potential barriers to entry exist within any market. Here are some examples of industries with high, medium, and low barriers:

  • High: Nuclear power plants, pharmaceutical, banking, satellite and space travel, airports, automobiles, telecommunications

  • Medium: Restaurants, insurance, mass-market retail products, alcohol, consulting, hotels

  • Low: web retailers and services, hairdressers, niche publications, lemonade stands, board games, bed & breakfasts, low-end retail products, hot dog vendors

If a penny stock you’re interested in is already operating within a certain industry, then the higher the barriers to entry the better. Ideally, you want the companies you’re investing in to have a toehold in industries where it would be close to impossible for any new competition to arise.

If a company you like is entering a new industry or business line, you want the barriers to entry to be low, or at least easily manageable. As soon as the company is established within the space, you want to see the barriers to entry increase dramatically and thus lock others out, such as a new regulation or requirement that would be too difficult for new entrants to attain.

Barriers to new competition

One way to assess what the barriers to entry are, and thus to extrapolate whether a particular penny stock should be able to clear them, is to imagine yourself in the shoes of that company. To eventually enter the market, what barriers to entry will you need to overcome? Barriers include

  • Regulations: If a company needs approval of an organization or regulatory body to operate, that represents a barrier to entry.

  • Preexisting competition: Entering a market that is already saturated with large competitors will be extremely difficult.

  • High customer loyalty: If most customers are happy with their current providers, the task of winning market share will be a hard one.

  • Technical requirements: Technical roadblocks include finding specialized staff and highly refined product specifications.

  • Material availability: If a company needs resources that are in high demand, ensuring adequate supplies serves as a barrier to entry.

By asking yourself what hurdles lie ahead for a penny stock, you can get a better understanding of how long and complicated the road may be.

The best first movers are the small ones

Being a first mover, which means the first company to sell a certain type of product or operate in a specific industry, can be a massive advantage. The very act of being first is a marketing angle in itself, but the new market is also wide open and devoid of any competition, at least at first.

Eventually, other competition will enter the market. Any time there are profits to be had, other businesses will crowd around to try to take a share.

Consider a (fictional) company that produces a breakfast cereal that is eaten with water rather than milk. Being the first business to offer such a product gives the company a 100 percent market share initially. As the concept becomes more well known, and the company starts generating sales, it needs to expect competition.

The first mover in any new industry should

  • Move quickly. The instant the first mover releases the new concept or idea to the public, it will be chased by competition battling for the newly created market share. The first mover needs to drive forward and never lose the leading position because being the leader is always a major advantage.

  • Lock in its market. Through trademarks, employees, patents, and aggressive branding and marketing, the first mover should solidify its position. By properly establishing itself in an industry, a company increases the difficulty for others to enter the space, while strengthening its own position.

  • Hope for numerous competitors. If only one new competitor enters the new market, then it will go against the first mover. If dozens enter, they will battle each other, dispersing the footprint of each of them, and leaving the spoils primarily in the hands of the original company. The marketing efforts of the follower businesses have the added effect of spreading the word about the new industry.

Penny stocks that achieve first mover status are very often capable of achieving massive returns for investors. When they create a new industry concept, and therefore have 100 percent market share, they could be in for dramatic growth (in demand, sales, and earnings).

Being the first mover isn’t an advantage when the company needs to educate the market. Even a great idea needs to be introduced to consumers when it’s new, and nothing is more expensive than educating the market. Many times the first mover will run into bankruptcy presenting their product. Then the second mover can just step in and start competing for market share, without all the associated costs and efforts.