Barriers to Entry & Exit
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Singapore Power was first created to take over the electricity and gas business of the state provider, the Public Utilities Board in 1995 and was once considered as the only electricity company in Singapore. However, in 2001, Singapore Government took further steps in industry reform: separation of the natural monopolies (i.e. grid) from the competitive domain (i.e. generation and retail) in order to encourage competition and drive firms to be more cost-effective and avoid monopoly status that may hold negative effects for both the industry and consumers such as marketing complacency and loss of consumer solvency. Grid remained under Singapore Power, while each power plant was set up as a separate company to compete with one another. To name a few are: Senoko Power Ltd, Tuas Power Ltd, Keppel Merlimau Cogen Pte Ltd, Island Power Company Ltd… A. BARRIERS TO ENTRY:
What are barriers to entry?
“Barriers to Entry” are those factors that allow incumbent firms to earn positive economic profits while making it unprofitable for newcomers to enter the industry. There are two types of barriers to entry:
Structural barriers to entry
Strategic barriers to entry
1) Structural barriers to entry:
Structural barriers to entry have more to do with basic industry conditions such as cost and demand than with tactical actions taken by incumbent firms. Methods of structural barriers to entry used by Singapore Power: a. Control to essential resources
An incumbent is protected from entry if it controls a resource necessary for production and can use that resource more effectively than newcomers. In the case of Singapore Power, one of its subsidiaries, PowerGas has been Singapore’s sole licensed gas transporter and system operator since 1995, delivering both natural gas and town gas. This puts the whole Singapore Power at a prerogative position since Singapore Electricity Fuel Mix mostly relies on natural gas (natural gas makes up 77.8% of the Singapore electricity fuel mix). b. Sunk costs:
Sunk costs, from costs of specialized capital equipment to costs of government licenses, cannot be covered if a firm decides to leave the market. Sunk costs therefore increase the risk and deter entry. Singapore Power gained its competitive advantage in the market because electricity industry is such a capital-intensive industry with very high upstart sunk costs that incumbent has incurred but the entrant has not. If entry fails, then the entrant, unable to recover sunk costs will result in greater loss. In this way, sunk cost is a barrier to entry for other potential entrants in the industry. c. Government regulations/Statutory barrier to entry:
It makes entry more difficult because requirements for licenses and permits may raise the investment and level of technological know-how needed to enter a market, creating an effective barrier to entry. Singapore Power, being a leading energy utility company in the Asia Pacific, having all the advanced technology, investment and special know—how to ensure that Singapore electricity network is reliable and devoid of electrical outages, is therefore licensed by the government as the only grid owner in Singapore. In this case, we are saying that Singapore Power benefits greatly from favorable statutory barrier to entry. d. Learning curve (experience curve):
The learning curve refers to the advantages that flow from accumulating experience and know-how incumbents have over entrants by having stayed longer in the industry. Having been the major player in the electricity market for more than 10 years, Singapore Power distinguishes from entrants in their cutting-edge technology (Singapore Power has continuously commissioned and deployed new technology to enhance the performance and reliability of the whole electricity network such as the installation of the wireless Supervisory Control and Data Acquisition (SCADA) system for remote monitoring of 6.6 kV distribution network in 2008), specialized know-how, effective managerial expertise (leveraging technology to delight customers – SP Services). All these result from the benefits of learning and accumulated knowledge about the industry enjoyed by Singapore Power.
d. Network effect & Customer loyalty:
Asymmetries between Singapore Power and entrants also arise from the network effect: relationships with customers and suppliers that can take years to build. It is often very costly, time consuming and challenging for the entrants to match such competitive edge. Singapore Power has been providing electricity and gas transmission and distribution, and market support services to over a million industrial and domestic customers. Singapore Power would enjoy certain degree of customer loyalty because it has been seen as a leading and reliable gas and electricity provider for nearly 15 years. Customers would tend to place uncertainty over the reliability, quality and services of entrants, and therefore, there would be low chances that they will switch to another electricity and gas provider. e. Economies of scale:
Economies of scale enable incumbents to produce at a lower average unit cost as their production volume increases. It acts as a barrier and deterrence to entry by forcing new entrants to either compete on a large scale or accept a cost disadvantage in order to compete on a small scale. Since Singapore Power is one of the largest corporations in Singapore, benefits from economies of scale can be realized. Some inputs, such as research and development, advertising, managerial expertise and skilled labor are expensive, but because of the possibility of increased efficiency with such inputs over the years through learning curve, the cost of such inputs will be spread over increased production units to reduce average production costs. Moreover, with a larger scale of production, Singapore Power may also apply better organizational skills to its resources, such as a clear-cut chain of command, while improving its techniques for production and distribution.
2) Strategic barriers to entry:
Strategic barriers, in contrast, are intentionally created or enhanced by incumbent firms in the market, possibly for the purpose of deterring entry. Methods of strategic entry deterrence used by Singapore Power: a) Limit pricing:
In a particular market, an existing firm may be producing a “monopoly” level of output, and thereby making supernormal profits. This creates an incentive for new firms to enter the market and attempt to capture some of these profits. One way the incumbent can deter entry is to produce a higher quantity at a lower price than the monopoly level. The strategy is known as limit pricing. Not only will this reduce the profits being made, making it less attractive for entrants, but it also means that the incumbent is meeting more of the market demand, leaving any potential entrant with a much smaller market share. Limit pricing will only be an optimal strategy if the smaller profits made by the firm are still greater than those risked if a rival entered the market. It also requires commitment, for example the building of a larger factory to produce the extra capacity, for it to be a credible deterrent.
By holding cost advantage, Singapore Power can turn it into an entry-deterring strategy by offering low electricity tariff. By doing so, it will satisfy the public and market consumers, gain trust and favour from the government for “not leveraging on the monopoly status as the grid owner to charge higher electricity price”. An evidence of the limit pricing strategy implemented by Singapore Power is that on 1 October 2008, SP PowerAssets concluded a second 5-year regulatory price reset with the Energy Market Authority (EMA). Grid charges were reduced by an average of 8-11 per cent in various customer supply categories, without compromising the high quality performance standards of its transmission and distribution networks.
b) Horizontal differentiation & Vertical integration:
Horizontal differentiation and vertical integration serves to enhance market power and improve production system of the incumbents.
Singapore Power is a vertically integrated power company which not only operates in the Singapore market but also expands their market activities in Australia. This helps Singapore Power to build broader and valuable network relationships with stakeholders throughout the Asia Pacific region. None of electricity companies in Singapore has so far been able to diversify or expand their market and business portfolio as Singapore Power did and has been doing. The Singapore Division of Singapore Power group has four related business units: SP PowerAssets, PowerGass, SP PowerGrid, SP Services. It also has a technical management consultancy arm, SP Global Soultions, and related business unit – Singapore District Cooling.
Singapore Power would benefit from reduced risk level in the case of Singapore Power, as a result of being diversified. If one of its business units falls to generate good profit, the other business units might be able to offset. By having a related diversified business portfolio with four related business units, Singapore Power will be able to vertically integrate its vertical chain to become more production-efficient by fully utilize and exploit its capacity of factory plants, machinery and equipment, enhance the coordination of its production flows through the vertical chain and prevent leakage of strategic technical know-how and private information to avoid technology and strategy replication. c) Capacity expansion:
When an incumbent expand their capacity, they can expand output at a relatively low cost by exploiting some of the existing plants and equipments or technology. At the same time, the incumbent has chances to capture more market demand, thereby increase their market share. This will have the effect, intended or not, of substantially reducing the entrant’s post-entry profits. If post-entry profits are less than the sunk costs of entry, the entrant will stay out.
In FY 08/09, SP PowerAssets continued its network infrastructure development, planning for additional capacity to meet the growing power needs of Singapore. Progressive upgrading and replacement of existing transmission assets were also carried out to ensure the continuity of the electricity grid’s track record of high reliability. Moreoever, PowerGas successfully extended the town gas network by 5.6 km to reach more customers in new public housing estates, private residences and commercial premises.
B. BARRIERS TO EXIT:
To exit a market, a firm stops production and either redeploys or sells off its assets (A change in ownership does not entail stopping production is not considered exit). 1) Assets write-offs:
Exit barriers often stem from sunk costs, as in the case of Singapore Power, because large fixed costs are effectively sunk, the marginal cost of remaining operation is low and exit is less attractive. 2) Closure costs:
Closure costs include redundancy costs, contract contingencies with suppliers and the penalty costs from ending leasing arrangements for property. Singapore Power, as many other large firms, is bound by some obligations that they must meet whether or not they cease operations. Examples of such obligations include labour agreements and commitments to existing contracts with workers and suppliers. Obligations to input suppliers are a very significant exit barrier for such a diversified firm like Singapore Power planning exit from a the electricity industry, since the suppliers to a specific division are assured payment out of the resources of the rest of the firm. 3) Government restriction:
Government restriction is another significant barrier to exit for Singapore Power since it has been so far, the most important utility company in Singapore, the only grid owner and Singapore’s sole licensed gas transporter and system operator. The proper functioning of Singapore Power serves to maintain the whole electricity network of Singapore. Such public-service oriented company plays a significant role in fulfilling public needs and cannot be replaced in a short-term. Other power generating and retailing companies in the market are held dependent on Singapore Power to function and provide electricity services.
As a result, companies like Singapore Power cannot exit the industry without regulatory approval. Despite the division of power and market share in the industry shared by other entrants, Singapore Power, being a very established firm in the industry, can still remain as a leading and largest power company in Singapore and stay competitive by exploiting some of the following barriers to entry that may deter potential entrants from entering the industry, mitigate the threats of competition and prevent existing power generating companies or power retailing companies in the market from becoming another grid owner and outperform Singapore Power.