Sunk Costs and Concentration in Homogeneous Product Industries

Research by Pankaj Ghemawat and others in the 1980s focused on sunk cost commitments, which can support entry deterrence. Alternatively, sunk costs can create exit barriers, potentially increasing the number of firms in an industry. This study combines information on cost structure, production capacity, and sales for 31 chemical products to consider factors that determine the number of competitors in a homogeneous product industry. After controlling for market size and cost of entry, the number of producers increased with the ratio of sunk to variable costs. This is consistent with exit barriers, but not with entry deterrence. Excess entry was greater when plants were geographically dispersed, suggesting that fragmentation into submarkets facilitates firm survival when sunk costs are high.