Barriers to exit

In economics, barriers to exit are obstacles in the path of a firm which wants to leave a given market or industrial sector. These obstacles often cost the firm financially to leave the market and may prohibit it doing so. There are various factors that can affect barriers to exit.

If the barriers of exit are significant; a firm may be forced to continue competing in a market, as the costs of leaving may be higher than those incurred if they continue competing in the market. Sometimes, when firm operate at low profit or at loss, they still choose to compete with others. Major factors of this decision making is high barriers to exit. [1]

Definitions

There are various definitions of "barrier to exit", this means the absence of one common approach to define barriers to exit. [2]

In 1976, Porter defines "exit barriers" as "adverse structural, strategic and managerial factors that keep firms in business even when they earn low or negative returns.” [3]

In 1989, Gilbert used the definition “costs or forgone profits that a firm must bear if it leaves the industry...Exit barriers exist if a firm cannot move its capital into another activity and earn at least as large a return”. Direct costs of exit and indirect opportunity costs of exit are covered in this definition. [4]

In 2004, Carlton and Perloff used the definition "barriers to exit are generally treated as an indirect form of barriers to entry, i.e. if it is costly to exit an industry there are weaker incentives for entry"

All of these definitions above have in common is that barriers to exit are obstacles that may force a firm to continue operating in a market.

Types of barriers

There is a variety of factors that can affect the ease of exit. Type of barriers to exit can mainly divided into direct exit costs and indirect opportunity costs of exit. [5]

Direct exit costs:

  • Labor related exit costs. Costs related to protect employees’ contractual rights for example, staff redundancy costs and insurance benefits.
  • Regulatory exit requirements. Some costs that require firm to comply in order to exit market. For example, remediation costs due to environmental regulations.

Indirect opportunity costs of exit:

  • Sunk costs. Barrier to exit for incumbent firms since the committed assets represent non-recoverable costs. Examples of sunk costs including assets specificity, advertisement campaigns and promotions, research and development costs.
  • Long-term contracts. Some long-term contracts with buyers or suppliers can be barrier to exit as it might have penalty costs from cutting short agreement.

Other factors that may form a barrier to exit include:

  • Potential upturn. Firms may be influenced by the potential of an upturn in their market that may reverse their current financial situation.
  • Government and social restrictions. Often based on government concerns for job losses and regional economic effects.[6]

Relationship between barriers to exit and barriers to entry

Eaton and Lipsey (1980) pointed out that barriers to exit are barriers to entry. [7]

There are two reasons to believe that such interdependence exists. Both reasons are related to new entrants and incumbents.

  • First-mover advantages. Investments by incumbent firms in durable and specific assets may create first-mover advantages, this create barrier to entry for new entrants. It also limits the potential for displacement.
  • Sunk costs. Sunk cost is barrier to entry, and it provides incumbents with an advantage. Sunk cost is also barrier to exit since the sunk cost represent non-recoverable costs.

Implications

As more firms are forced to stay in a market, competition increases within that market. This negatively affects all firms in the market and profits may be lower than in a perfectly competitive market.

Example

Exit barriers are especially high in the airline industry. Airplanes are specialised assets in airline industry as airplanes only can be used by the airline industry. Resulted in a dramatically decreased demand for travel due to coronavirus and travel ban for many countries. Therefore, many airline companies operating at low profit or at a loss. However, because of high exit barriers, many airline companies still choose to operate and compete in airline industry.

Market structure

Perfect competition - free entry and exit

Monopolistic competition - free entry and exit

See also

References
  1. Karakaya, Fahri (August 2000). "Market exit and barriers to exit: Theory and practice". Psychology & Marketing. 17 (8): 651-668. doi:10.1002/1520-6793(200008)17:8<651::AID-MAR1>3.0.CO;2-K.
  2. Secretariat. "Barriers to exit in competition". Organisation for Economic Co-operation and Development.
  3. Porter, Michael (1976-12-01). "Please Note Location of Nearest Exit: Exit Barriers and Planning". California Management Review. 19 (2): 21–33. doi:10.2307/41164693. JSTOR 41164693. S2CID 154746142.
  4. Richard J, Gilbert (1989). Chapter 8 Mobility barriers and the value of incumbency. Elsevier B.V. pp. 475–535. ISBN 9780444704344.
  5. Secretariat. "Barriers to exit in competition". Organisation for Economic Co-operation and Development.
  6. Michael, Hitt; Duane, Ireland; Robert, Hoskisson (2019). Strategic management : competitiveness and globalization. Cengage Learning, 2019. ISBN 9780170373159.
  7. Eaton, Curtis; Lipsey, Richard (1980). "Exit Barriers are Entry Barriers: The Durability of Capital as a Barrier to Entry Author". The Bell Journal of Economics. 11 (2): 721-729. doi:10.2307/3003391. JSTOR 3003391.
  • Johnson G, Scholes K and Whittington R, (2006), "Exploring Corporate Strategy", Prentice Hall International (ISBN 978-0-273-71017-2)
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