Private Equity Interview Practice Test

Raising barriers to entry by increasing fixed costs is a classic way incumbents deter new entrants. When a firm commits to higher fixed costs—such as heavy R&D spending for new product development or investing in scalable manufacturing capacity—it creates a substantial upfront hurdle and ensures profitability hinges on reaching a large, steady volume. This makes the entry decision riskier for outsiders, who must cover these fixed expenses before any meaningful margin appears. Since fixed costs don’t vary with sales in the short term, the incumbent can spread them over more units as output rises, keeping per-unit costs low while the entrant struggles to reach that scale. The result is a stronger incentive for potential entrants to stay out or invest elsewhere.

The other options don’t deter entry the same way. Reducing capital expenditure lowers the barrier to entry, making it easier for newcomers to start. Relying on aggressive marketing can help entrants gain visibility but doesn’t raise the structural hurdle to entry. Increasing product commoditization lowers differentiation, which often makes competition more price-driven and inviting rather than deterring potential entrants.