Exit Barriers: What they are, and how they impact industry profitability

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What are industry exit barriers

Exit barriers are factors that make it difficult for companies to leave the industry – costs (or losses) that are incurred if a company were to depart. These barriers keep firms in the industry – even if that industry is unprofitable.

In some instances, the costs incurred with leaving the industry may be substantially more than the yearly loss from remaining in the industry. Rather than exit and incur the large loss, the company may decide it is easier to remain in the industry and suffer a more modest loss each year. Alternatively, if there is a lot of equipment where the value can not easily be recouped, they may decide that it is better to remain in the industry, and hope that conditions improve in the future. 

Why can high industry exit barriers reduce industry profitability

Exit barriers can make a low profit or unprofitable industry even less profitable. Companies that are making a loss – and who may want to leave the industry – remain. Rather than leaving, their remaining presence results in even more competition than – potentially companies fighting over the remaining market share, reducing profits below what would be possible were at least some firms decide to exit the industry. 

Examples of industry exit barriers

Dedicated machinery and equipment that can't be resold

The loss associated with an inability to re-sell or re-purpose capital investments can act as a strong exit barrier. Especially for custom or dedicated machinery without significant demand, there may be very limited resale opportunities for companies to recoup their prior investments. Given they are likely to take a significant loss on machinery (potentially machinery that has yet to be deprecated on the company’s accounts), companies may be much more reluctant to exit an industry than if they can readily recoup their prior investments. 

Long term leases that can't be broken

Another very common exit barrier is long-term leases that can’t be broken (or have significant costs associated with terminating). It is not unusual within retail for example to have locations with leases lasting multiple years. While these have some benefits for tenants – allowing investments to be made in the facility, and security that the lease rate will not be hiked unexpectedly – they also make it very difficult for companies to wind down unprofitable operations. Retail locations may be kept open, even if they are unprofitable, because of the difficulty, cost, or inability to terminate lease agreements. 

High costs associated with making employees redundant

Another exit barrier may be the costs associated with making employees redundant. Payments to compensate employees for layoffs vary widely by country and can be substantial – potentially requiring several months of wages to be paid. 

An inability to bring a facility back online if it is closed

While some companies can temporarily shut down (potentially in periods of low industry demand), and come back into operation with minimal disruptions, for others it is essentially impossible to bring back online once they have been closed. For large manufacturing sites, it may essentially be impossible to re-hire all of the roles and bring the site back online after it has been shut. This can act as a strong exit barrier, with companies keeping facilities online (even if they are not currently profitable), in the hope that industry conditions improve. 

High costs associated with decommissioning a facility

A final exit barrier is the costs associated with decommissioning a facility. Some sites have substantial costs that are incurred as part of shutting down the facility – nuclear power stations for example take many decades to decommission, with millions of dollars incurred in the decommissioning process. Given these high costs, companies may opt to push off the decommissioning decision – again remaining in the industry even after it is no longer profitable. 

Summary: Exist barriers encourage firms to remain in an industry even after it is no longer profitable

The key thing to remember when there are high exit barriers is that it can cause companies to remain in an unprofitable industry because the perceived costs of leaving the setting are greater than remaining in the industry. Whether it is direct costs associated with actually existing, such as redundancy or decommissioning fees, or losses associated with re-selling machinery at a steep markdown, exit barriers can potentially further suppressing the profitability of the industry through overcapacity.

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