Wednesday, December 2, 2009

The Silverdome and the Fixed Cost Dilemma

Posted by Jeff Lipshaw

Edwards-Mark Mark Edwards (William Mitchell, left), a guest blogger at Concurring Opinions, has an interesting post on the recent fire sale disposition of the Silverdome, the former home of the Detroit Lions, primarily on the subject of bargaining power between landlords and tenants, and the importation of contract law principles into residential and commercial leasing.  Mark commented on the "Michigan" aspect of the Silverdome's decline, and I felt a personal tug, because I'm a Michigander born and bred, still own a home there, and I started kindergarten at the Herrington School about a mile from the Silverdome, in a little neighborhood just across Featherstone Road from what many years later would become the site of the Silverdome.  I wrote a comment over there I'm re-posting in large part here, because there is, it turns out, something kind of Michigan about the problem.

Mark suggests that the Silverdome problem has to do with the commercial power of the tenant, but I see it somewhat differently.  It strikes me that it arises because of the non-fungible and substantial fixed nature of the asset (which indeed was dictated by the tenant at the outset). You could have a very powerful tenant in an attractive office building in mid-town Manhattan, able to dictate terms versus the owner, and not have the Silverdome problem. You could also have a smaller building and not have the Silverdome problem (I see a lot of restaurants that clearly used to be A&W Root Beer Drive-Ins.)

If there is something particularly “Michigan” about the Silverdome problem, it’s the problem of dealing with the redeployment of large fixed assets when the forces of creative destruction take down an industry. As a former executive in the chemical industry, I can attest to the dilemma of the rational impulse to continue to operate fixed assets, even when they are not returning their total costs, because, in the short term, there is a marginal return on the marginal cost. It’s Microeconomics 101 – you operate at a loss on total costs until you reach the shutdown point of no marginal profit. If it were just one chemical plant sitting somewhere that has been made non-competitive (somewhere after not returning total costs and extending to shutdown), it would be unsightly, and the owners would have taken the loss, but it wouldn’t be a crisis. It’s a crisis in Michigan because it’s happened to an entire industry at the same time.

It’s also not the first time it’s happened to an industry in Michigan. Take a drive some time around the Keweenaw Peninsula, the part of the U.P. that juts into Lake Superior. Calumet, Michigan and the surrounding township used to have 25,000 people there, mining copper. I think about a thousand live there now. Copper Harbor, at the very tip of the peninsula, still has street grids laid out.

Nor is it unique to Michigan – see steel towns in Pennsylvania, mills and factories in Massachusetts. But I’m not sure anything has ever compared to the auto industry in terms of the dependence of whole regions and nations. During the Chrysler bailouts of the 1980s, I remember hearing George Will, supporting the idea, say that something like one-sixth of the U.S. GDP was related to the auto industry.

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During Thanksgiving football I marveled that Detroit is able to sustain an NFL franchise. It seemed the cameras never panned out enough to show how full the stands were.
Related to the A&W comment, I am constantly giving directions saying things like "Turn left at the building that used to be a KFC" so it would seem that in that situation the uniqueness of the structure may even add value to the new tenant in that the location is easy to find and describe.

Posted by: Gretchen Duhaime | Dec 2, 2009 7:10:55 AM

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