Author: Dr. Athanasios Pallis
Entry barriers are placing economic, regulatory, and locational impediments in seaports.
1. Entry Barriers in Seaports
Although the port industry has become a more open market in the last decades, entry barriers for those wishing to provide port services remain substantial. A barrier to entry is anything that prevents an entrepreneur from instantaneously creating a new firm in a specific market. In contrast, a long-run barrier to entry is a cost that must be incurred by a new entrant that incumbents do not, or have not had to, bear. In some cases, port reforms introduced a few private port operators, yet they have failed to lower the entry barriers for more firms interested in providing port services.
Barriers to entry in seaports are classified into three categories:
- Economic entry barriers such as the need to make long-term, capital intensive, and fixed investments.
- Regulatory and institutional entry barriers such as no license given to new firms willing to operate in a particular port.
- Locational (geographical), space-related, entry barriers such as having no attractive site in the port for an entrant.
2. Economic Entry Barriers
The first type of economic entry barrier in seaports is the absolute cost advantage that might enjoy an existing port service provider. This advantage might be the result of one or more of the following factors:
- The scale of operations is not big enough to allow the presence of additional service providers. This issue is relevant when the minimum efficient scale (MES) for providing a port service is large compared with specific market size. This phenomenon frequently happens in the case of seaports. In such conditions, potential new entrants face a competitive disadvantage resulting from a smaller scale or need to create a capacity similar to that of the incumbent firm. This latter option would be unlikely if it were to result in substantial excess supply, the prospect of a price war, and losses for both the incumbent and the entrant.
- The existing service provider (incumbent) enjoys a better location in the port. When the incumbent is perfectly located, for instance, concerning access to hinterland transport modes such as rail, road, and inland waterways, or at a site with good maritime accessibility, the entry of competitors in less attractive vacant sites is unlikely to materialize.
- Incumbents benefit from accumulated public investments. In most seaports, public port authorities have invested in infrastructures such as rail terminals and quays. In some cases, they have also invested in the superstructure. Furthermore, the opportunity costs of the land are not always included in the land price paid to the landlord by port-service providers. Thus, existing leaseholders may benefit from accumulated public investments. Incumbents have a long-term cost advantage if such benefits from public investments are no longer available for entrants, such as changing policy guidelines. Consequently, new entrants face costs that incumbents have not had to bear. Thus, such subsidies not available for new entrants are clearly a barrier to entry. The incumbent has had lower initial investments and enjoys relatively high profits.
Specialized equipment and high capital requirements alone are not an entry barrier. Entrants are, in many cases, multinationals (such as Hutchison Port Holding), others are affiliated to large state-owned conglomerates (such as the Chinese COSCO), or might even be groups of investors with access to the capital markets.
A. Minimum Efficient Scale of port services
The Minimum Efficient Scale (MES) for providing a port service depends on the cost curves for this provision. MES is the smallest scale at which the output can be produced at a minimum average long-run cost (i.e.it is reached when marginal and average costs no longer decrease when capacity is expanded) under the assumption that the terminal is operating with a given technology.
For port services such as a container terminal, or an iron ore terminal, the MES is quite large. In a small market size relative to the MES, economies of scale are only fully realized with one supplier of port services. A second, smaller competitor may have a structural cost disadvantage that prevents profitability. It may exit, leaving the market to one operator with a sufficient scale. The large size of the MES might explain the relatively high concentration of most port services.
The MES in a port market might be reduced by a public authority, mainly the port authority, that owns assets and leases them to private firms. In such an arrangement, the public authority can secure scale economies, such as equipment purchasing, maintenance, port planning, and terminal layout, and let relatively small firms provide port services. Policy options also include tender procedures to ensure the economic rent accrues to a public organization and tariff monitoring and benchmarking of port service providers. Furthermore, access to port services can be regulated based on essential services access regulation. Port services and port facilities can be termed essential if they are necessary components of transport chains and economically viable alternatives (e.g. outside the port or other ports) are not available. Such essential facilities include towage, pilotage, mooring, stevedoring, and shore handling and are strategies to introduce port competition.
B. Switching costs
The second type of economic entry barrier is the magnitude of switching costs. These are costs associated with the decision of a port user to switch from the incumbent port service provider to the new entrant. They can come in several forms and often determine the capability of new entrants to start operations in a port:
- Switching from one port facility to another may require the investments of port users. In some cases, such costs are insignificant; for example, shipping lines can easily switch containers from one transshipment facility to a competing facility. In other cases, switching costs may be substantial. For instance, port users (shipping lines, forwarders, or shippers) may have long-term contracts with rail or barge companies or may be invested in dedicated transport equipment. Other port users may have invested in facilities at the site of the port-service providers (for instance, car manufacturers that carry out pre-delivery inspection and small repair activities at the site of a terminal operator). Such port users cannot easily switch to another port service provider. For most bulk transport flows, switching is prohibitive because of the specific investments made to create an efficient overall transport chain (including hinterland transport). This also explains why cargo owners frequently invest in terminal facilities: to avoid being exposed to independent terminal operators with dominant market positions.
- Switching costs may also be high through the bundling of the services of the incumbent port-service provider. For instance, a terminal-operating company may also provide pilotage, towage, and hinterland transport services. Such an arrangement creates a barrier to entry in each of the separate markets, especially when some of the bundled services are natural monopolies. The bundling of port services is partly due to the geographical and functional integration of ports in wider regions and networks. With the rapid restructuring of the supply chains in which ports are embedded, ports are now elements in value-driven chain systems, not simply places with particular functions. In the emerging flow-based system, the various supply phases are closely synchronized, and the various transport services are frequently bundled.
C. Sunk costs
Sunk costs, such as networking, marketing, and advertising costs, cannot be recovered once a firm decides to leave the market and, thus, might stand as the third type of economic barrier to entry. Sunk costs include the essential investments in embeddedness in specific networks in order to achieve integration in maritime transportation and supply chains. The quest for long-term relationships with partners to reduce uncertainty and improve coordination leads port authorities to implement strategies to strengthen partnerships with other players by offering incumbent firms the conditions to develop strategies to succeed. Embeddedness in such a strategic network enhances the competitive position of a firm. For new firms entering the market, inclusion in such networks may demand resources and be costly to achieve, because of the importance of reputation, trust, and experience, for example. Should a firm decide to leave the market, the investments required for inclusion in strategic networks cannot be recovered.
3. Regulatory, Institutional and Geography Entry Barriers
Regulatory and institutional entry barriers might make entry into a market costly, time-consuming, or impossible. In a substantial number of ports, policy-makers or port authorities effectively limit the number of terminal-operating companies, towage companies, and other port-service providers. Sometimes these limits are set by explicit entry criteria that effectively limit the number of competitors. In other cases, the port authority or some other relevant policy-maker decides about an entry based on its interpretation of the rules, such as compliance with local, national, and international environmental requirements and the development policy of the port.
In some cases, not only do port authorities grant authorizations, but they also provide port services. This provision presents fundamental obstacles to market openness. Furthermore, in a situation where the state in one of its various forms (national, regional, local) owns a port-service provider, this operator enjoys an implicit state guarantee: the state would not allow a state-owned operator to go bankrupt. This situation is a deterrent to new entry, as the state-owned operator can potentially engage in predatory pricing: that is, set prices below cost to remove competitors from the market.
Provisions in leases, concessions, and other operating agreements, particularly those involving long-term investments by private operators, often provide these operators with some degree of protection against new entrants. For example, a terminal operator who has been given the concession to operate a container-handling facility might have exclusive rights to handle containers in the port during the concession period. Furthermore, lengthy concessions, even though they provide benefits in the short run that are often passed on to the users, can also provide opportunities for rent-seeking.
The existence of regulatory entry barriers can be understood, at least in part, with insights from public choice theories. They are the result of the lobby efforts of incumbent firms to persuade policy-makers to deter further entry and secure profits or serve the wish to extract rents. Both of these explanations underline the adverse welfare effects of entry barriers, with the latter associated with higher levels of informal economies rather than better quality goods and services.
These public-choice theories suggest that that the emergence of legal and institutional entry barriers to serving the interests of incumbent firms, public port authorities, or state agencies may not be ruled out in advance. Ports are traditionally strong, locally-oriented communities with close relationships between the port authority and port service providers. In such an environment, entry barriers may develop to serve the interests of the incumbent port community. An alternative explanation along the same lines, namely that legal and institutional entry barriers are the result of the lobbying of interest groups, is that a public port authority creates entry barriers in order to collect economic rents. In many ports, port authorities offer additional services such as pilotage, towage, and port labor. Entry barriers for such services increase the market power of the port authority in these markets.
Natural barriers that constrain port capacity can limit entry, particularly firms requiring land in the port. In many ports, there is simply no space for additional berths, warehouses, and other facilities. The lack of suitable locations and environmental regulations constrain expansion to protect incumbents from new entrants. Such entry barriers are particularly relevant if alternative ports are imperfect substitutes, such as differences in hinterland infrastructure or nautical access, including deviation from main routes. Such deficiency is the case in many ports and for many commodities. Greenfield port development (building port infrastructure in a completely new location) is not usually a viable strategy for entry. Large investments are often required for dredging, quay construction, access roads, and port superstructure. In most existing ports, public authorities have contributed a large share of these investments without direct cost recovery. Thus, private greenfield port development is unlikely to emerge. This supposition further strengthens the case for low entry barriers in existing port complexes.
5. Policies to Reduce Entry Barriers
Lowering entry barriers is desirable from a public-interest point of view:
- First, it enhances market contestability. The relevant issue is how accessible (contestable) a market is for entrants. If entry to (and eventually exit from) the market by new competitors is easy, the market is contestable. Such contestability puts pressure on incumbent firms not to charge excessive prices. This contestability is particularly relevant given the increased market concentration arising from economies of scale in modern cargo-handling technologies, the rise of global players in the terminal-handling industry, and horizontal and vertical integration in the shipping industry through the investments of shipping lines in dedicated terminals. Often just the threat of entry (potential entry) is enough to persuade incumbents not to abuse their dominant market position. The possibility of entry introduces an element of competition. Although there may not be many operators in the market, it is competitive, with prices not far from social opportunity costs.
- Second, lower entry barriers increase the level of intra-port competition. As abuse of market power is curtailed, and port-service providers have incentives to specialize and differentiate their services from competitors in the same port, real intra-port competition is more beneficial for port users (and thus consumers) than contestable markets with only one incumbent. However, owing to the large minimum efficient size of many port services, such intra-port competition is not always viable.
- Third, lower entry barriers allow for the faster implementation of new technologies and business models. Even when intra-port competition is established, the entry of additional competitors can be an important engine for introducing innovations. New firms often generate business dynamism and economic growth, particularly when exogenous changes in demand challenge the current activities of incumbent firms. New firms are thought to be particularly innovative. There is evidence that the process of entry (and exit) plays a part in reallocating resources from low to high productive units. Firm entry plays an important part in creative destruction as a mechanism that helps shift resources from less to more productive units, as in a Schumpeterian model with entrepreneurial learning under uncertainty. When incumbents fail to exploit exogenous shifts in costs or demand (perhaps because the required innovations would be rent displacing), entry is an important determinant of industry performance.
Policies to reduce entry barriers concentrate on creating conditions that allow entry without hindering the survival and growth of profitable firms. Some of the potential policy options to reduce entry barriers may not be applicable or necessary in all seaports, but may well be useful in some. While some of these options require national policy initiatives, port authorities can implement others:
- Structural cost advantages of the incumbent can be prevented by using effective pricing mechanisms, such as tender procedures, to grant the right to provide a service or a terminal concession. In such procedures, all cost (dis)advantages are internalized in the price.
- Another policy capable of reducing entry barriers is to split a terminal into parts, forming separate concessions. The existence of different market segments increases the viability of intra-port rivalry. Dividing facilities to accommodate various port service providers may be difficult. Much depends on the geographical layout of the port, the available traffic, and the minimum capacity additions taking into account the lumpiness of port investments.
- In the long term, many physical/locational entry barriers can be overcome by building in adjacent locations, extending out into the sea, and so forth. Furthermore, new concepts and technologies can be introduced to limit the need for space in the port. For example, an inland container depot can help create additional space for terminals in the port.
- In most cases, having a public agency, the port authority, which invests in port-specific and site-specific assets and leases these assets to the private sector, is a policy option to reduce entry barriers related to switching costs and sunk investments. A further role for the port authority to reduce entry barriers is that of a smart coordinator that enables networks of stakeholders. Such a coordinator can help overcome decisional and operational fragmentation. The port authority acts as a cluster manager by coordinating the integrated port services provided by various actors. Such an active port authority can increase opportunities for the entry of small and medium-sized companies.
- Policy reforms that promote transparent concession procedures forbid exclusive contracts and ensure the absence of discrimination are also relevant for reducing entry barriers. Reducing the (maximum) duration of authorizations and concessions also lowers entry barriers and rent-seeking opportunities. Concessions and authorizations need to be sufficiently long to allow companies to recover their fixed investments and earn a normal return on their investments. However, excessively long durations limit opportunities for entry and reduce the dynamism in the sector. In many European countries, durations of concessions of 50 years in the case of limited investments, 75 years for significant investments in movable assets, or 99 years for immovable assets are common practice. The reduction of maximum durations would certainly lower entry barriers.
- Entry barriers can be further reduced by the stability of the regulatory regime and the presence of mechanisms for dispute resolution. Uncertainty and transaction costs are reduced, and lower entry barriers ensue.
- Additional regulation, such as antitrust policies and merger regulations, targets to prevent incumbents from benefiting from high entry barriers. Most countries, economic zones (like NAFTA), and supranational entities (the European Union) have developed a general legal framework to ensure low entry barriers. Such regulation is not industry-specific but applies overall. In most countries, competition regulations protect entrants from predatory pricing by incumbents, such as exclusive contracts with suppliers. Mergers and acquisitions are also subject to regulatory oversight. These are relevant in the container-handling market, given its strong consolidation. The question arises whether operators have established a dominant position, limiting the potential of market competition and discouraging newcomers. The general competition law can and often does go hand in hand with industry-specific regulations.
- Chapter 5.1 Inter-Port Competition
- Chapter 5.2 Intra-Port Competition
- Chapter 5.3 Port Marketing
- Chapter 5.4 Port Pricing
- de Langen P.W. and Pallis Α.Α. (2007). Entry Barriers in Seaports, Maritime Policy and Management, 34(5), 427-440.
- Kaselimi, E.N., Notteboom, T.E., Pallis, A.A. and Farrell, S., (2011). Minimum Efficient Scale (MES) and preferred scale of container terminals. Research in Transportation Economics, 32(1), 71-80.
- Notteboom, T. E., (2002). Consolidation and Contestability in the European Container Handling Industry. Maritime Policy and Management, 29(3), 257-269.