Durable and specialized assets

If the assets of a business, either fixed or working capital or both, are highly specialized to the particular business, company, or location in which they are being used, this creates exit barriers by diminishing the liquidation value of the firm's investment in the business. Specialized assets either must be sold to someone who intends to use that in the same business (and if they are specialized enough, to use them in the same location) or their value is greatly diminished and they must often be scrapped. The number of buyers wishing to use the assets in the same business is usually few, because the same reasons that make the firm want to sell its assets in a declining market will probably discourage potential buyers. For example, an acetylene manufacturing complex or a rayon plant has such specialized equipment that it must be sold to another owner for the same use or scrapped. An acetylene plant, furthermore, is so difficult to dismantle and transport that the costs of doing so may equal or exceed the scrap value. Once the acetylene and rayon industries began to decline, the potential buyers willing to continue to operate the plants up for sale were close to nonexistent; those plants that were sold were sold at enormous discounts to book value and often to speculators or desperate employee groups. Inventory in a declining industry may also be worth very little, particularly if it normally turns over very slowly.

If the liquidation value of the assets of a business is low, it is economically optimal for the firm to remain in the business even if the expected discounted future cash flows are low. If the assets are durable, the book value may greatly exceed the liquidation value. Thus it is possible for a firm to earn a book loss but it be economically appropriate to remain in the business because the discounted cash flows exceeded the opportunity cost of capital on the investment that could be released if the business were divested. Divesting the business in any situation in which the book value exceeds the liquidation value also leads to a write-off, which has some deterring effects on exit that will be discussed later.

In assessing the exit barriers caused by asset specialization in a particular business, the question is whether or not there are any markets for the assets as, or as part of, a going concern. Sometimes assets can be sold to overseas markets at a different stage of economic development, even though they have little value in the home country. This move raises the liquidation value and lowers exit barriers. Whether there are overseas markets or not, however, the value of specialized assets will usually diminish as it becomes increasingly clear that the industry is declining. For example, Raytheon, which sold its vacuum tube-making assets in the early 1960s when tube demand was strong for color TV sets, recovered a much higher liquidation value than the firms that tried to unload their vacuum tube facilities in the early 1970s, after the industry was clearly in its twilight years. Few, if any, U.S. producers were interested in purchasing by this later time, and foreign firms supplying vacuum tubes to less advanced economies either had already purchased tube-making equipment or were in a much stronger bargaining position once U.S. decline was obvious.

- Michael E. Porter, Competitive Strategy: techniques for analyzing industries and competitors, The Free Press, a division of Macmillan, Inc., 1980, pp. 259-60.