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> Because the 747 is so old, most of the development costs are long since amortized. This gives Boeing more pricing flexibility if the two companies are competi

• fsckboy 6y ago
  Generally, the sunk cost argument is used to mean "just because you've put a bunch of money in does not mean that your "progress" is worth what you paid for it, and is therefore not a justification to keep putting more money in; you've already lost what is gone so that's off the table." However, if a company borrowed the money it "sunk", it still has to pay that money back from future sales; if it was raised through equity, continued losses will continue to drag the share price down. Sunk cost is not a free lunch argument. This is where the "competing for production slots" with passenger variants comes in. The program could only be run cash flow positive at a higher rate of production than the orders were justifying, and that is on the back of the higher priced passenger variants. As it was, Airbus needed to amortize overhead costs over two production lines, the overhead was too much for one production line; worth it in the short term only if you expected sales to pick up in the future. (and you can't shut down a production line and then fire it back up without a lot of extra overhead, so for example, they can't just keep the A380 idea around in case demand develops) For each piece of the program, there are separate sunk costs. The sunk cost of design does not justify sinking further funds into building an assembly line, if the expected production is not going to pay for itself, even though the design you now paid for is so to speak "free!" And the freighter variant required new sunk costs before it would be ready to sell (the 747-8 itself cost $5B more on top of the already existing 747 platform) And anything Airbus chose to do, Boeing could disrupt by dropping it's prices/profits; there is a lot of "chess" entailed in marketing these large scale projects. Would have potentially been a different story had there not been competition.
  • rlpb 6y ago
    > However, if a company borrowed the money it "sunk", it still has to pay that money back from future sales; if it was raised through equity, continued losses will continue to drag the share price down. Sunk cost is not a free lunch argument. Even if a company has borrowed the money it "sunk", it's still in its interest to maximize revenue even if that's not enough to pay the interest on that loan. The alternative would to make even less, and cause its debts to rise even further. Maximizing revenue means charging the most the market will pay. Not participating because the market won't pay enough to "pay back on the initial investment" would not be maximizing revenue. Not participating because doing so would mean operating at a loss _excluding the sunk cost_ makes sense, but that's not what we're discussing here. > The sunk cost of design does not justify sinking further funds into building an assembly line, if the expected production is not going to pay for itself, even though the design you now paid for is so to speak "free!" The cost of building or operating an assembly line was not the subject of my comment. I was only referring to your comment about Boeing's development costs being "already amortized". That part makes no difference to the economics of the situation.
    • fsckboy 6y ago
      Companies are required to keep books according to accepted accounting principles, under which sunk costs are in fact on your books, and that's what financial analysts look at, and those costs you need to amortize, both financial accounting and tax accounting. When you build a new factory, you charge what you need to to pay the price of the factory down (or assembly line). You don't spend lavishly on an expensive factory and say "sunk costs, let's call that money gone, what's our marginal cost, ok, that will be our price." Rather, you charge as high as the market will bear and hopefully make a profit. You don't control the market of course, and you have to respond to competition. A competitor who has already paid down their investment has more flexibility than you do because they have more room to play with price and still report a profit. The sunk cost fallacy refers to your decision making. What is the value of a project? its prospects, not what you have already spent. What has your spending done? It's bought you the option to make this decision. Do you call the option? Well, it doesn't matter how much you paid for it. Did you make money on the option? That does matter how much the option cost. Some of it's psychological and perhaps not rational: if you have engaged in a big money losing project, if you pull the plug on it, your stock price will go up, because the market says "whew, at least we know they are not going spend money on that project any more" which I guess is them suspecting you will fall prey to the sunk cost fallacy. But these are complex decisions to make, especially in Europe where shutting down production entails a lot of costs that would be better put to something productive, and as you don't know the future, you try to figure out ways to make the project work.