I was going to write something on priorities when I realized I needed to explain costs first. So then I was going to write about costs but I realized I needed to explain sunk costs and opportunity costs first. So here I am, writing about sunk costs when I really want to talk about priorities. That’s ok though, sunk costs are still a worthwhile topic.

So what the heck are sunk costs? Wikipedia tells us:

“In economics and business decision-making, sunk costs are retrospective (past) costs that have already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken. Both retrospective and prospective costs may be either fixed (that is, they are not dependent on the volume of economic activity, however measured) or variable (dependent on volume).”

Which is useful if you already have an MBA but not so useful if you’re trying to figure out what the heck I’m talking about. So, let’s try this one more time only this time without fancy economics terms.

Sunk costs are costs which you’re not getting back regardless of the decision you make. They’re gone, they’re spent, they’re sunk and you’re never getting them back. Therefore, sunk costs should have no impact on your current decision.

Notice how I bolded that last part? There’s a reason for that and that reason is because most people totally ignore that part and make one bad decision after another as they fail to recognize what sunk costs are. Let me give you an example.

My friend Bob started a business. He tried to make a go of it for 2 years. In those two years he spent around 50k of his own money to get the business started. The business hasn’t been going real well so now he faces a choice of staying with the current business idea or trying something new. If he wants to keep trying his current business (idea A) he will need to invest another 2 years and another 50k. He estimates his chances of making idea A successful with this additional investment at about 20%. His new idea (idea B) will also require a 2 year and 50k investment but this new idea has a 25% chance of success. So how does Bob look at his option set? Well, if Bob is like most people he thinks of it this way:

• Option A – Invest an additional 50k and 2 years in Idea A. 20% chance of success.
• Option B – Throw away the 50k and 2 years investment in Idea A. Invest 50k and 2 years in Idea B. 25% chance of success.

And thus, Bob choose to stay with Idea A. After all, idea B means investing the same amount of money AND throwing away all that past investment for only a slightly higher chance of success. Doesn’t seem worth it. This my friends is the sunk cost problem.

Sunk Costs Are SUNK and You Will NEVER Get them Back

Sunk costs are gone. They’re in the past. Nothing you do will get them back for you. Those 2 years and 50k Bob spent are gone. He will not get them back. He will not get a refund nor a rebate nor a credit for those years and dollars. They’re gone and sunk and therefore should not be used in decision making. The true options Bob is facing are:

• Option A – Invest 50k and 2 years in Idea A. 20% chance of success.
• Option B – Invest 50k and 2 years in Idea B. 25% chance of success.

Now which option should he pick? This time it’s obvious. Option B offers a higher chance of success for the same resources spent and so should be picked every time.

Sunk Costs Are Sunk

I want to emphasize this again because a lot of people are going to argue here. They’re going to say, what about getting a refund, or selling the business or blah blah blah. Whatever! If you can get some money back then those are not sunk costs and should be part of your decision. However, a cost that does not change regardless of your decision is a sunk cost and should not be a part of your decision criteria. Sunk costs are SUNK! They are gone, you will not get them back and therefore they should not have an impact on your decision.

Where Else Does This Apply?

Sunk costs are easily seen in financial issues like the above, but where else do people make mistakes like these? How about relationships? How often have you heard someone say “well, I’m not really happy but I’ve already put in so much time and effort into this relationship…” or how about in health “well, I’m not really hungry but I’ve already paid for this meal…” How about travel? “Well, I don’t really want to go but I already paid for the ticket and I can’t get a refund…” STOP! Just stop using this “I’ve already” excuse. Your decisions should not be based on the resources and time you already spent, they should be based on the resources and time you will need to spend to get what you want.
Is there a chance this relationship will work? Is the time and effort you’re going to need to spend worth it? Is there a better chance for you to find the partner of your dreams if you end this relationship now and move on? Those are the right criteria to think about, not time you already spent.

Are you hungry? Will you get pleasure out of eating this meal? Are you going to enjoy going to that show more than doing something else? Remember, either way you’re not going to get the price of your meal or of your tickets back, so why consider that in your decision?

I think the old saying “stop throwing good money after bad” says it best except I will also add “stop throwing good time after bad.” If there’s no chance of getting time, money and resources back then they should not be a factor in your decisions. Remember, sunk costs are sunk. Don’t sink yourself by going after them.