Bariers To Exit

Barriers to exit

What is the process of exit from an industry? Is it efficient or inefficient? Classics on investment behaviour, such as Salter (1966) and Nickell (1978) and introductory economics text suggest that the exit process works well and that the least efficient plants close first. There are many examinations made which proves that non-optimal exit behaviour may occur, stressing the problems arising from game playing between competitors and game playing between firms and governments. Six major exit barriers are identified from the literature review, based on Porter's classification of the barriers as economic, strategic and managerial. The effects of these six barriers(cost of divestment, operating fit, marketing fit, forward vertical integration, backward vertical integration and number of years of association of the businesses unit with the firm) on the decision to exit from markets are tested by using a decision-making exercise. The results indicate that executives consider forward and backward vertical integration to be the most important barriers to exit, followed by the number of years the unit is with firm, was found significant only for the maturity stage of the product life cycle. As expected the regression coefficients were showing an inverse relationship between the presence of the barriers and decisions to divest.

As the name implies, exit barriers make it difficult for firms to leave the declining market, so their presence is likely to lead to firms fighting to maintain their positions for as possible. First we could discuss the extent to which production relies upon durable or specialized assets- if assets are highly specialized (i.e. they have no alternative use) this will mean that they have negligible liquidation value because nobody will want to buy into the declining market. As a result, if the firm keeps the assets working it might be able to earn a stream of returns that exceeds the price they would fetch if they were sold. Another barrier will be the size of the exit costs associated with the firm's obligations-it s very rare for firm simply to be able to shut down its production facilities and sack its employees without some form of compensation or redundancy package being offered to its employees. The size of this compensation bill may have an obligation to dismantle its facilities and this can be extremely costly. For example the nuclear power generator British Energy faces a dismantling cost for its nuclear reactors that runs into tens of millions of pounds. The presence of managers' emotional attachments to the company - very often a rational approach to exit decision may possible because managers take pride in their achievements to date and hang on too long in the declining market. This problem may be especially acute if the firm runs a single market business, because managers may not have an alternative job to go to and may think that their options in the job market will be limited by the stigma of having run their current company into crisis(even if the crisis was the result of unstoppable terminal decline). The degree of corporate interrelatedness - if the firm is a multi-product company which enjoys economies of scope it may be reluctant to leave the declining market since to do so may hurt its competitiveness in its other markets.

Almost all the literature on inefficiencies in exit behaviour highlights the existence of conflicts between various parties. Harrigan (1980) has speculated that the process of exit is a strategic game between competitors. If any player quits the industry not only may it have to abandon its investments and so not be able to re-enter easily, but also, its rivals may benefit from the reduction in capacity and competition. In fact plants (firms) with larger market shares quit first regardless of relative cost positions. This kind of analysis is more appropriate where the number of firms in the industry is small rather than large (Cosstutta and Garillo, 1986). The strategic games between players in an industry involve also some important games between owners and governments; governments bear some certain political and cash costs when a plant is closed which are not directly borne by the owners. Usually unemployment workers are paid by the State and not the firm which quit. As Bower (1985) documents, governments may pay or force owners to keep plants open when profitability criteria suggest that they should be closed.

In an examination on the UK steel casting industry it is found that between 1979 and 1983 some twenty-seven plants were closed, accounting for about a quarter of capacity. Many of the closing plants were not the least profitable; in a sample of eight out of fourteen closures in 1982/3 it is found that three had positive cash flows, whereas six of the twenty-eight immediate competitors which did not close made cash losses. It is found that firms which were diversified and financially strong seemed more likely to close than those which were not, and it is speculated that in these firms there may have been fewer conflicts between the various stakeholders: owners, debt holders and managers.

A closure takes place when the expected profit (loss) from operations is less than the interest which would be earned (or paid) on the capital released from closing now, less any anticipated capital gain on the residual value resulting from deferring closure. There is point often overlooked that firms may differ in the efficiency of closing as well as the efficiency of operations. There might be a firm's plant that has a higher scrap value that of another firm, this could be because the managers of the first firm are more flexible in switching their talents into other sectors. We could make the obvious point that managerial factors may reinforce the inclination of the single activity firm to continue trading. It is easier to fire other people than to fire your self.

During the autumn 1982 a rationalisation scheme has been sponsored by the UK government and the merchant bank Lazard Brothers. It has provided for cash payments to firms which scrapped capacity and fourteen plants were scraped. This scheme is described more fully in Baden-Fuller and Hill (1984). Taking these phases together about one quarter of the UK steel castings industry's capacity was dismantled. The initial analysis of the data provided by the 'Economic journal' (1989) leads us to the conclusion that diversified firms are more likely to quit first. (63%) of the reduction

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