Overestimating Barriers to Entry: The Rise of Craft Distillers

The alcoholic beverage industry has experienced a significant change in the past few years, as a wave of new entrants has emerged.  A large number of "craft distillers" have exploded onto the scene.  According to the American Distilling Institute, the number of small distilleries has risen tenfold over the past ten years.  According to a recent article in the Wall Street Journal, the large players are taking notice. They don't want to get caught unprepared, as they were to some extent when craft beer began to disrupt their business.  

The rise of craft beer and craft distilleries raises an important strategy point.  For years, people argued that the barriers to entry in markets such as beer and distilled spirits were high because of economies of scale, brand equity, route to market advantages, and the extensive advertising and marketing required to launch a new product.  What's happened?  How have startups cracked these markets?  It's become easier to enter these days for a variety of reasons.  Perhaps most importantly, one can launch a new brand more easily today than in the past.  You don't need traditional marketing and advertising approaches, which can be very expensive.  You can use guerrilla marketing and social media to introduce a new product.  Authenticity has become a key product attribute for consumers, and entrants can play on that trend.  Retailers are looking for new, high margin, premium products to add to their portfolio.  Deregulation has occurred, with some laws restricting the sale of alcohol at certain days, times, and locations coming off the books.  Moreover, some rules restricting production have changed as well.  

What's the broader lesson here?  Economies of scale might be significant, but we can't overestimate their ability to prevent entry.   Niche players can still emerge.  Other entry barriers can decline, precipitating entry despite scale disadvantages.   Moreover, some advantages of being small often are overlooked.  While no one niche player may take substantial share, as a group they may create a significant disruption in the marketplace.  The strategic threat is not from one particular entry, but from a class of entrants.  That's a concept that incumbent players in many industries should keep top of mind. 

Irrationality in the Airline Business

This Wall Street Journal headline did not shock me today, even though it speaks to an incredibly irrational set of behaviors:  "New Startup Airlines Crowd the Skies."   The article describes how a number of new players ("a flock of startups") are entering the airline industry, including a firm that has brought the People's Express brand back to life.  

Why do I say that the headline describes irrational behavior?  Consider the following important fact: for over one hundred years, the airline industry has been one of the least profitable markets on earth.  Richard Branson once joked that it was actually quite easy to become a millionaire; all you had to do was begin as a billionaire and then enter the airline industry!   Look back at the leading players in the industry in the 1970s and 1980s.   Most of them either no longer exist, or they have experienced a Chapter 11 reorganization at one point or another.  For those familiar with Michael Porter's five forces framework, a quick analysis shows that the industry is terrible along each dimension.   In short, the industry structure is incredibly unattractive.   

Why, then, are firms continuing to enter this industry?  Yes, the barriers to entry are quite low, but why enter if the likelihood of success is so low?   I think it comes down to the fact flying has always had a special allure.  Succeed, even for just a brief time, and you can become a celebrity.  Think about the famous names throughout the industry's history:  Howard Hughes, Juan Trippe, Richard Branson, Herb Kelleher, Michael O'Leary, Freddie Lake, and Don Burr.  Just take a look at the quote that ends the Wall Street Journal article today: 

"It's a high-profile, sexy business," says Henry Harteveldt of Atmosphere Research Group, a travel research firm. "And if you keep a lid on costs, have the right strategy, aircraft and managers, you can make money." What's more, the U.S. needs more airline competition, he says. The problem is: "the best markets are spoken for." 

There you have it.  It's sexy.  It's high-profile.  You can become a celebrity CEO if you succeed, or you can hob nob with CEOs who already are celebrities.  Unfortunately, many entrepreneurs in this industry forget one key lesson that I always teach my students when we study industry structure:  sexy industries are not always very profitable.