Exit barriers intensify competitive rivalry by stopping businesses that are losing money from leaving the industry when there is little or no hope of future profitability.
The Five Forces model from Michael Porter is an important way to understand the competitive pressures within an industry and at the centre is competitive rivalry.
What Are The Major Exit Barriers?
I’ve split the discussion of exit barriers into two sections for rational barriers backed up with economic logic and emotional barriers which create commitment beyond the level where it makes sense financially.
Rational Exit Barriers
- Specialised assets – some industries require specialised assets and capabilities which cannot create value in other markets. Assets that can be re-used elsewhere or those that are easily adapted make it easier for a business to move from one market where it is struggling to another where prospects look brighter.
- Contractual arrangements – the business may have entered into contracts with customers and suppliers where breach of contract creates punitive damages which the business cannot afford. Even if there is nothing in writing, a business may be unwilling to break its commitments because of relationship and reputation damage that could affect other parts of the business or group.
- Vertical integration with other business units – a group may have a number of subsidiaries connected in the industry value chain. While one may be losing money (although transfer pricing makes it difficult to get a realistic arms-length assessment), damage may be done to the other businesses.
Emotional Exit Barriers
- The business may come under political or social pressure to keep an important factory unit open because it is a key part of the local economy. Sometimes financial help may be available but more often the business fears damage through bad publicity.
- The owner or senior managers may have an emotional commitment to the business which makes it unwilling to concede defeat even when the economic justification for exit is compelling. Perhaps the business was where it all began and therefore there are heritage reasons to keep the business going which link into the core story. Perhaps there is loyalty to employees or fear for what it means for their own personal positions.
The Impact Of Barriers To Exit
Whatever the cause of the barriers to exit, the end result is that firms stay in the market when it is better for them and their competitors that they leave in an orderly manner.
It therefore makes sense for the market leader or someone determined to win the “last man standing” strategy in a declining market to help struggling firms to leave and take out the excess capacity.
The worst that can happen is for the business to go bankrupt and to be bought for a song by an ambitious management team with an idea to shake-up the industry with a strategic innovation and the financial backing to make it happen.
More often, the existing management and shareholders find the finance to buy the business back in a pre-pack administration deal, free of the high levels of debt and contingent liabilities that stopped an effective turnaround taking place. It may lead to a viable business or the industry economics may cause future problems.