Review of Industrial Organization 20: 291–304, 2002.
© 2002 Kluwer Academic Publishers. Printed in the Netherlands.
2002 Presidential Address Industrial Organization Society
Sunk Cost and Entry
FEE/F&O, University of Amsterdam, Roetersstraat 11, NL-1018 WB Amsterdam, The Netherlands
Abstract. The usual mechanisms by which sunk costs are said to affect entry are through raising the
expected average cost of an entrant, relative to that of incumbents. I show that in standard models
and in the absence of risk premia imposed by ﬁnancial markets on an entrant’s cost of capital, sunk
costs may make entry unproﬁtable because of their effect on the post-entry unit costs of incumbents.
Keywords: Entry, entry barriers, sunk cost.
JEL Classiﬁcations: L40, O31, O38.
Sunk costs are typically thought to constitute a barrier to entry because of the im-
pact of sunk investments on the decisions of a potential entrant. Thus Baumol et al.
(1982, p. 291) write that “The need to sink costs can be a barrier to entry” and say
of sunk costs that “Their role as barriers to entry depends on the risk to which they
subject the entrant.” In one formalization (1982, p. 299) it appears that the risk in
question affects an entrant’s expected rental rate of capital services, and that “Any
such difference in rental rates must be attributed to the possibility that the entrant
may ﬁnd himself forced to depreciate his capital fully during the disequilibrium
Baumol et al. (1983, p. 494)
similarly highlight the impact of cost sunkenness
on the unit cost of entrants (emphasis added):
Suppose that a unit of capital purchased at a price of β per unit could be
sold or utilized elsewhere after T for a salvage value of α ≤ β. ...If α<
β, the entrant can offer a price only as low as its average cost over T ,and
this will be somewhat higher than the true economic average cost because
I am grateful to Jeroen Hinloopen for comments. Responsibility for errors is my own.
Discussing Schwartz and Reynolds (1983).
MacLeod (1987, p. 143) distinguishes between M- or malleability-sunk costs (resale price of
capital goods less than purchase price) and T -sunk costs (possibility of exit available only at the end
of time intervals of length T ).