Sunk Costs

One of the most important decision-making tools arises from an understanding of sunk costs. The term “sunk costs” means those costs which have already been incurred but which will never produce a future benefit, even if they might have produced a past benefit. Obsolete software comes to mind.

Technically, sunk costs can be calculated by subtracting the salvage value from the book value. Thus, if you are carrying a now useless machine which has an undepreciated book value of a thousand dollars, and you could get a hundred dollars for scrap, then the sunk cost would be nine hundred dollars. That money is sunk. Gone. Finished. Auf wiedersehen. Bon débarras. Fuhgedaboudit. No crying over spilled milk.

But humans, rats, and mice can’t leave well enough alone. Along with our rodent relatives, we have a propensity to cling to sunk cost assets, dreaming that they may yet do us some good. This propensity is known as the Sunk Cost Fallacy, essentially the opposite of Cut Your Losses.

Let’s say that you hired a junior based on a good resume and great interview, yet a year later you keep finding egregious errors in his work. You send him on courses, you counsel him, you get him special software, all to no avail. You have spent a hundred thousand dollars on salary and benefits and countless hours coaching and checking, and dealing with outraged clients, and you keep telling yourself that just one more reprimand, one more pat on the head, and a miracle will occur and the junior will pay you back in spades.

You believe all this because you want to, because you need to, because you want to prove to the world you did not make a bad decision. But deep down you know, and all your friends know, that the absolute best you’ll ever get is a fresh start, and you will never, never, never recapture your sunk costs. And you also know that the likelihood of that Damascus Road moment is slim to none.

The Sunk Cost Fallacy has application well beyond business. It’s really just a formal name for “don’t throw good money after bad”. Bad marriages, dumb investments, wobbly partnerships, threadbare friendships (including Facebook), unused subscriptions and health club memberships, tenuous church affiliations– the list goes on and on. There is no current benefit and no prospect of a future benefit, but instead of getting on with the promise of tomorrow, we suck the thumb of yesterday.

For two decades I “learned to play the guitar”. One Saturday morning it broke upon me that after thousands of hours of practice, I still was not even average, and I never would be. I’m rhythmically and musically challenged, but all along I kept insisting that all those hours of practice would pay off some day. Well, they didn’t and they wouldn’t, and each hour spent on practice was one more hour not spent on something I did well and truly enjoyed. So I slipped my dear old guitar in its velvet-lined hard case and put it in the closet, where it remains to this day.

This is not to suggest that we be disloyal to those who are in our charge, but it is to suggest that our lives will be fuller and richer and more productive when we stop chasing things we will never catch and investing in those things from which there will never be a return. Letting go of stuff which may once have had value (or not) but which clearly has no future benefit is the only way we can find time, energy, and resources to do the things that truly benefit us and all those around us.