The impact of exit barriers on industries
High exit barriers are the costs associated with shutting down the operations of a firm. There may be substantial costs associated with decommissioning a facility – potentially greater than the ongoing losses of keeping the firm running. Or it may be essentially impossible to re-start the firm once it is shut – encouraging companies to remain in operation despite losses in case conditions improve in the future.
The effect of exit barriers is thus to keep firms in the industry – including in situations where they are making a loss. Money is continued to be spent on an unprofitable firm because this is the less-bad option relative to shutting the firm down.
Why firms remaining in the industry is bad for profitability
The key reason why high exit costs are bad for industry profitability is thus that companies remain in the market despite being unprofitable – further increasing competition. Rather than an equilibrium achieved, where unprofitable firms leave, in turn reducing industry capacity, and potentially allowing prices and profitability to recover, unprofitable firms remain.
Final thoughts: Is the industry susceptible to cyclical demands
The danger of high exit barriers may be particularly great in settings with fluctuating or cyclical industry demands. This further increases the tendency for firms to remain in the market in the expectation or hope that conditions will improve. High exit barriers, coupled with the hope that conditions will improve, can perpetuate over-capacity as companies remain in unprofitable markets.