Barriers to Exit: Examples, Tax Implications and Overview

What Are Barriers to Exit?

Barriers to exit are obstacles or impediments that prevent a company from exiting a market in which it is considering cessation of operations, or from which it wishes to separate.

Typical barriers to exit include highly specialized assets, which may be difficult to sell or relocate, and high exit costs, such as asset write-offs and closure costs. A common barrier to exit can also be the loss of customer goodwill.

Barriers to exit can be compared with barriers to entry.

Understanding Barriers to Exit

A company may decide to exit a market because it is unable to capture market share or turn a profit. The dynamics of a particular industry or market may change to such an extent that a company may see divestiture or spinoff of the affected operations and divisions as an option. However, circumstances, including internal and external, regulations, and other impediments, may prevent the division or inter-related business from being divested.

For example, a retailer may wish to eliminate underperforming stores in certain geographic markets—particularly if the competition has established a dominant presence that makes further growth unlikely. A retailer might also wish to leave one location for another that offers potentially higher foot traffic or access to a demographic of customers with higher incomes. However, the retailer might be locked into a lease with terms that make it prohibitive to shut down or leave their current location.

Tax Breaks and Regulations

A company could have received certain benefits, such as tax breaks and grants from the local government that encouraged it to set up shop in a location. Those incentives may have come with high penalties if the company attempts to move its operations before fulfilling the obligations and terms outlined in the deal.

Government regulations could also make it difficult for a company to exit a market. Banks are often considered necessary for lending and promoting economic growth in a region. If there are not enough banks or competition in an area, the government might block the sale of a bank to another party.

Costly Equipment

High barriers to exit might force a company to continue competing in the market, which would intensify competition. Specialized manufacturing is an example of an industry with high barriers to exit because it requires a large up-front investment in equipment that can only perform specific tasks.

If a specialized manufacturer wants to switch to a new form of business, there might be financial constraints due to the large sum of capital or money already invested in the cost of the equipment. Until those costs have been covered, the company may not have the resources to expand into a new line of business.

Impact on the Environment

Industrial companies that wish to exit can face extensive cleanup costs if considering closing a factory or production facility that used or produced materials that left environmental hazards at the site. The expense of removing the material may outweigh the benefit of relocating the operation.

Special Considerations

High barriers to exit might hurt existing companies but might also create opportunities for new companies looking to enter the sector. A new company could buy up the assets of a company wishing to exit at a favorable price. The company selling the assets might not be in a good negotiating position, due to debt or unprofitability, to garner a high price for the assets.

In other situations, companies might buy distressed assets of a competitor to prevent a new company from entering the market. If a company is trying to leave an industry that had high barriers to exit, a competitor can use the high barriers to exit to their favor and negotiate a low price for the assets. Although the cost might be significant for the company making the purchase, it would eliminate a competitor and prevent a new company from entering the market by purchasing the assets.

Example of Barriers to Exit

Let's say Delta Airlines wants to exit its business but has a substantial amount of debt owed to investors—funds that were used to purchase airplanes. Airplanes can only be used by the airline industry, meaning they're specific assets. Also, depending on the age of the planes, the assets might have a low scrap value.

As a result, Delta might have difficulty finding a buyer for the planes to pay off any debt and exit the industry. Delta would have to find a competitor in the industry that had the capital to buy the fleet or look to the government for financial assistance.