Barriers to exit

Barriers to exit are obstacles that prevent a firm from leaving a market or industry sector even when continued operation yields low or negative returns. Michael Porter defined the concept in 1976 as "adverse structural, strategic and managerial factors that keep firms in business even when they earn low or negative returns."^[1] These barriers force companies to remain in unprofitable markets because leaving costs more than staying.

Origins and theoretical background

The concept was formally introduced by Michael E. Porter and Richard E. Caves in their 1976 publication "Barriers to Exit" in Essays on Industrial Organization in Honor of Joe S. Bain. Porter expanded on this work in his article "Please Note Location of Nearest Exit: Exit Barriers and Planning" published in California Management Review the same year. The theory became integral to strategic management when Porter incorporated it into his Five Forces framework in Competitive Strategy (1980).

Exit barriers represent a critical but often overlooked aspect of industry analysis. Traditional economic theory assumed firms could freely enter and exit markets. Porter challenged this assumption. His research demonstrated that structural factors frequently trap firms in declining industries.

Types of exit barriers

Specialized assets

When a company invests heavily in specialized equipment or facilities, disposal becomes problematic. A semiconductor manufacturer with $2 billion in fabrication plants cannot simply repurpose that equipment for other uses. These assets often have minimal scrap value. The machinery serves only one function.

Sunk costs

Non-recoverable investments create psychological and financial barriers. Research and development expenditures, advertising campaigns, and employee training programs represent money that cannot be recouped upon exit. Managers find it difficult to abandon projects where significant resources have been committed.

Labor-related costs

Employee severance packages and pension obligations can amount to hundreds of millions of dollars. In countries with strong labor protections, workforce reduction requires lengthy negotiations and substantial compensation. General Motors spent approximately $1.5 billion on employee buyouts during its 2009 restructuring.

Long-term contractual obligations

Lease agreements spanning 10-20 years cannot be easily terminated. Supply contracts with penalty clauses lock firms into ongoing relationships. Customer service commitments extend beyond the product lifecycle. Breaking these agreements triggers significant financial penalties.

Government and regulatory restrictions

Authorities sometimes block exits to protect employment. Utility companies face particular scrutiny. Nuclear plant operators must fund decades of decommissioning activities. Environmental cleanup requirements impose massive closure costs on chemical and mining operations.

Strategic interdependencies

A business unit may supply components to other divisions. Shared distribution networks create operational dependencies. Exit from one segment could damage the company's position in related markets. IBM maintained its mainframe division partly because it supported consulting and software businesses.

Emotional and psychological factors

Family businesses often resist exit despite poor performance. Founders identify personally with their enterprises. Pride prevents acknowledgment of failure. These factors were observed in studies of declining industries throughout the 1980s.

Industry examples

The airline industry demonstrates high exit barriers clearly. Aircraft represent massive specialized investments. Routes and landing slots have been built over decades. Employee contracts include substantial severance provisions. Pan Am continued operations for years after becoming financially unviable, finally ceasing in December 1991.

Steel manufacturers face similar constraints. Integrated mills require continuous operation to function efficiently. Blast furnaces cannot be easily mothballed. Environmental remediation of steel plants costs millions. Bethlehem Steel operated at losses for years before finally liquidating in 2003.

Chemical companies encounter severe environmental barriers. A herbicide manufacturer closing operations might spend $50-100 million on contamination cleanup. The costs of exit exceed the losses from continued operation in many cases.

Market implications

High exit barriers produce overcapacity in declining industries. Firms that should leave remain active. Price competition intensifies as participants fight for shrinking demand. Profit margins compress across the entire sector. New entrants face warning signals about future exit difficulty. Investment decision making must account for both entry and exit considerations.

Infobox4 See also

References

Porter, M.E. and Caves, R.E. (1976), Barriers to Exit, in Essays on Industrial Organization in Honor of Joe S. Bain, Ballinger Publishing Company
Porter, M.E. (1976), Please Note Location of Nearest Exit: Exit Barriers and Planning, California Management Review, Vol. 19, No. 2
Porter, M.E. (1980), Competitive Strategy: Techniques for Analyzing Industries and Competitors, Free Press
Harrigan, K.R. (1981), Deterrents to Divestiture, Academy of Management Journal, Vol. 24, No. 2

Footnotes