Threat of New Entrants to Commercial Banking Industry

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Table of Contents

Introduction
Economies of Scale
Working capital requirement
Brand Identity
Conclusion
References

Introduction

The recent domination of the United States in the global commercial banking industry does not mean that commercial banking experienced a lack of competitors or new entrants from other parts of the world. This fact is proven by the quick development of Barclays bank and HSBC group.

The surfacing of alien competitors with the capital required, innovative technologies, and executive skills as well as financial crisis have started to weaken the market share of the banks of North America. This means that the USA commercial banking industry is faced with the threat of new entrants (Johnson, Scholes & Whittington, 2006, p.206). The threat of new entrants into this industry serves as a direct constraint on the profit margins of established banks in the USA. Any industry that is earning a return on capital will tend to attract firms from outside the industry (Porter, 1998, p. 220).

Economies of Scale

The banking industry is characterized by the development of the internal and external economies of scale and the economies of scope. The need of any bank to permanently develop and grow explains the existence of economies of scale. When the bank is opening more branches, the cost of their opening decreases, and the bank becomes subject to economies of scale (Williamson, et al, 2003, p. 329).

Economies develop during the first three years of their existence, and after this period the profits start decreasing. This fact explains the connection between the declining curve of the economies of scale and the currently observed global economic crises. The reasons for such a connection between the economy and banking industry include:

Division of labor and job specialization is directly related to the quality and speed of work dynamics. Respectively, increasing scale facilitates the development of job specialization and provides for work quality improvement.
Technological advances facilitate scale development as well. The capital investment provides for better cost-effectiveness of the service delivery in an industry.
With the improved technology of service delivery, the employees involved in the process become more efficient. Thus, learning is improved, and the employees with higher skills and more substantial knowledge constitute a barrier to new industry entrants.
High-skilled workers provide the company with the opportunity to reduce costs. The costs saved might be directed at technological updating of the company, which in its turn facilitates its better industry performance.
The creditworthiness of a bank is dependant on the size and actual assets it disposes of. Thus, a large-scale bank potentially has more developmental perspectives and is more attractive to customers.
During mergers and acquisitions, the economy of scale helps in reducing the tax margin of the acquiring bank (Williamson, et al, 2003, p. 329).
Customer deposits/loan ratio was increasing over the 5 years period however it started declining because of the financial crisis.

In the banking industry scenario, the competitive advantage in terms of economies of scale can be changed significantly with innovative technologies being introduced and huge mergers being carried out between banks. In terms of economies of scope, a huge variety of service lines are offered to cover all the customer requirements. The banks with all the necessary resources could easily overcome the competition in the market in this case. But again, with changing market conditions and the invention of newer strategies, like reduction of fixed costs and development of 24-hour service in the industry, economies of scale play an important role in the banking industry. Thus, economies of scale serve as another barrier to a new entrant to the banking industry.

Working capital requirement

Operating a bank in the USA requires a quite large amount of initial capital which includes deposits with a reserve bank. This means that the entry costs are so high that only a few new entrants can survive in the US banking industry. This starting capital requirement is one more barrier to new entrants to the banking industry.

Existing commercial banks have a cost advantage over new entrants regardless of economies of scale and capital investment required. This is the result of the low cost of recruitment, marketing, and advertising and cost efficiencies arising from economies of learning in the banking industry. An existing bank spends less on recruitment as compared to a new entrant-bank, and this difference is also a barrier to entry into the industry (Williamson, et al, 2003, p. 329).

Commercial banks are characterized by the specialized and diverse set of services they offer. This fact makes it difficult for any entrant into this sector to obtain a significant market share unless it is intended to be done through a merger, an acquisition, or a takeover. According to Johnson et al. (2006), this is one of the major barriers for new entrants as the newly emerged banks usually cannot specialize and diversify their services to the extent that the highly developed banking industry players can (Johnson et al, 2006, p.207).

There are many potential regulatory barriers in the commercial banking industry ranging from public licenses to patents, minimum deposits, and trade secrets. This industry is subjected to heavy government involvement through regulation, procurement, and depositor protection that also constitute the set of stringent and expensive barriers to entry (Williamson, et al, 2003, p. 329).

Brand Identity

Customers do not associate with any brand in this industry. Customers are looking for products that will satisfy their needs more than looking for a specific brand. Also, when analyzing advertising expenses for the industry, the majority of the companies do not have advertising expenses and the ones that do only spend approximately 5% to 7% of total income on advertising. The industry average is 8% spent on advertising. This means that joining the industry a bank should be ready to spend more on advertising.

The actually existing competition is not the only threat that characterizes the commercial banking industry. The likelihood that new banks may enter the industry, also known as the threat of new entrants, also affects the competition. In theory, any bank should be able to enter and leave an industry, and the existence of free entry and leaving means that profits always should be nominal.

Conclusion

Drawing from this, barriers that industries have for the new entrants are more than usual equilibrium adjustment policies; they are protective means developed by the existing industry players, who want to protect their market shares from new entrants attracted by the industry’s profitability (Johnson et al, 2006, p.208). Mergers and acquisitions are frequent in the commercial banking industry as the tools of either acquiring new entrants that threaten the market positions of the developed banks or as the means used by new entrants to establish themselves in the industry. The forecasted growth of the industry will inevitably result in more new entrants appearing, thus ensuring that the banks willing to exit the industry will be substituted.

References

Banking industry information (2008). Trend. Retrieved September 28, 2009, from

Johnson, G. Scholes, K. & Whittington, R. (2006). Exploring Corporate Strategy. New York: Prentice Hall.

Porter, M. E. (1998). Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: Free Press.

Williamson, D., Cooke, P., Jenkins, W. & Moreton, K. (2003). Strategic Management and Business Analysis. New York: Butterworth-Heinemann.

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