Blockbuster’s Sunk Costs

by Elaine Schwartz    •    Oct 20, 2010    •    755 Views

When is it bad to be good at something? Blockbuster has the answer.

As described by New Yorker columnist James Surowiecki, Toys ‘R Us, Barnes & Noble, and Blockbuster were known as “category killers” because they decimated their competition. They became so large and so successful that they made the rules. For Blockbuster, the “rules” were good and bad. They were the prime source of video rentals. Their stores were everywhere. Good? Yes, until the existence of the stores became the reason for keeping them. Bad? A delayed response to the internet. The success of Blockbuster’s business model stopped its creators from seeing its weaknesses. “Blockbuster just kept on throwing good money after bad.”

The Economic Lesson

The key idea here is “sunk costs”. When you have devoted 10 minutes to waiting in one position for a free parking spot, you have “sunk costs”. Having “spent” 10 minutes already, you are less likely to leave and look elsewhere.

Similarly, businesses have sunk costs when they invest in physical and human capital. Having put considerable dollars into a venture, they are less likely to abandon the idea. For Blockbuster, the sunk cost was “bricks and mortar”. They had thousands of stores with employees from the “top” in management to the “bottom” as part time store workers. It would have been very difficult to abandon so huge an investment.

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