A sunk cost is: A cost that has already been incurred and thus cannot be recovered. A sunk cost differs from other, future costs that a business may face, such as inventory costs or R&D expenses, because it has already happened. Sunks costs are independent of any event that may occur in the future. [Investopedia]
Nine years ago I took my first trip to Europe. I went to Florence with a college group and everything was old and magical, so to me it was new and exciting. There were all sorts of European shops, and I was particularly seduced by a purveyor of leather goods. Italian leather, right? I had my eye on a black leather overcoat, the kind that an unworldly college kid would have thought was really cool ten years ago. I “bargained” him down to just under three hundred dollars, hemmed and hawed, and made the purchase.
As it turned out, my untrained eye did not realize that the coat was lacking in quality. It had no lining, B-grade leather, and unconvincing stitching quality. To top it off, the coat was a poor fit, and at least half a size too big. I wore the coat a handful of times before it became a fixture of my closet, stored in a dust bag. It wasn’t until nearly six years later that I finally posted it on eBay, and shipped it off to a buyer for around thirty dollars–or a tenth of the price that I paid.
The coat is a classic example of a sunk cost. After I made the purchase, the purchase price itself was largely irrelevant. The money had been spent, and would not come back. The cost was sunk, in the past, immutable. Whether I paid three hundred, thirty, or three thousand dollars I was still in the exact same spot. I owned a coat that I didn’t wear that was taking space in my closet.
When you acquire an item your mind plays a trick on you. It assigns a value to the asset (in this case, my coat) that is not based on current reality, and instead based in the past. (Investors call this anchoring.) My brain had assigned a high value to my coat ($300), and was telling me to keep it. Logically, the coat was of no value to me. I should prefer $30 in my pocket to a coat that I never wear. Yet it took me six years to acknowledge the change in value and sell the coat.
To properly deal with a sunk cost you must explicitly deal with an asset’s current value. Any prior value or price is irrelevant. Rather, the question is: what is something worth from this point forward? You can see how this is often difficult.
When we began prototyping our Drinking Companion tablets at Brode, we purchased packaging and labeling products that we quickly realized would never be used because we had decided to go in a different direction. The trap is to say, “We bought this stuff, we need to use it.” But we fought the urge, and decided that we didn’t want a crappy product tarnishing our brand. We had already purchased those packaging and labeling products, the money was spent, history. Yet we still didn’t use them because we decided that in our current situation they had no value to us. We wanted to push forward with innovative packaging, and the old product would only keep us back.
Sunk costs can be emotional. Imagine that you’ve spent six months overhauling your online admin template and you are still creating more problems than solutions. Do you cut your loses and cancel the project? Or do you push forward? Remember, the hours that your team has spent are a sunk cost, and you can’t get them back. (One could write many books on sunk costs as they pertain to romantic relationships.)
When dealing with sunk costs, it’s critical to address reality, and how things are now. Never let old valuations or unlikely hypotheticals hold the wool over your eyes in a way that keeps you from making the right tough decisions, and pushing your company forward.
Marc Brodeur just wants everyone to be awesome. His first company, Brode, the first professional drinking companion, makes a special vitamin that helps promote proper hydration and detox when drinking alcohol. Follow him on Twitter and Tumblr.
