DP6162 Are Sunk Costs a Barrier to Entry?

Author(s): Luís M B Cabral, Thomas Ross
Publication Date: March 2007
Keyword(s): barriers to entry, sunk costs
JEL(s): L13
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6162

The received wisdom is that sunk costs create a barrier to entry - if entry fails, then the entrant, unable to recover sunk costs, incurs greater losses. In a strategic context where an incumbent may prey on the entrant, sunk entry costs have a countervailing effect: they may effectively commit the entrant to stay in the market. By providing the entrant with commitment power, sunk investments may soften the reactions of incumbents. The net effect may imply that entry is more profitable when sunk costs are greater.