Market concentration,contestability,and sunkcosts

Market Concentration, Contestability, and Sunk Costs Author(s): Ioannis N. Kessides Source: The Review of Economics and Statistics, Vol. 72, No. 4 (Nov., 1990), pp. 614-622 Published by: The MIT Press Stable URL: http://www.jstor.org/stable/2109601 . Accessed: 10/03/2011 12:10
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MARKET CONCENTRATION,CONTESTABILITY, ANDSUNK COSTS
loannis N. Kessides*
Abstract-This paper provides an exploratory assessment of the theory of contestability that is based on a diverse sample of industries and introduces a new important determinant of market concentration. The results of the paper indicate that the variables determining the degree of contestability of markets are significant correlates of market concentration. Sunkcosts account for a substantial portion of the sample variance of concentration even after technological factors are controlled for.

We postulate that the share of sunk outlays ("sunkenness") is likely to be low in industries using capital that can be easily leased, or using capital for which an active second-hand market exists, or capital which depreciates very rapidly. Alternatively, theintensities of the rental and resale markets in an industry could be viewed as proxies for the mobility and fungibility of the I. Introduction capital employed in the industry. Our principal objective is to provide an exT HIS paper seeks to complementthe technoploratory empirical assessment of the theory of logical (i.e., scale economies) explanation of concentration by assessing the influence ofvari- contestability that is based on a diverse sample of ables which the theory of contestable markets industries rather than a few special cases. For suggests are pertinent in the determination of this, we focus on the set of determining forces industry structure.1 This theory emphasizes the that contestability suggests are pertinent in estabrole of sunk costs. The need to sink a given lishingthe nature of entry conditions and ultiamount of capital upon entering a market gener- mately in shaping industry structure. Our results ates an asymmetry in the incremental cost and strongly confirm the statistical significance and incremental risk faced by a potential entrant and quantitative importance of the factors determinan incumbent firm. The entrant's incremental cost ing the "sunkenness"of capital (namely, the inincludes the irrecoverable portion of the entry tensities of the rental and resale markets and the investment which is bygone to the incumbent. It rate of depreciation) in explaining the observed is in this sense that sunk costs constitute an entry inter-industry differences in the level of market barrier. In addition, sunk costs enhance the en- concentration. trant's...