Sunk costs refer to money, effort, and time already invested that you will not recover no matter what you do.
It’s human nature to try. But when you understand sunk costs, you make better choices. When you can clearly explain sunk costs, you help others make better decisions too.
A Tough Call
Here’s an example. If you’re sea kayaking in the Pacific Northwest, the quality of your decisions has a direct correlation to success — and survival. I was part of a group of eight paddlers planning on a 12-mile trip with a 2-mile crossing of Case Inlet. The weather report the night before predicted some wind with possible showers and thunderstorms in the afternoon.
At 7:40 a.m. we loaded our boats. The lightning was already splitting the sky and thunder came right on its heels. As our put-in was an hour north, my sister and I decided to go anyway and see if by the time we got there conditions had improved.
Once there, we all gathered around and discussed our decision. Our trip leader, Bob, was inclined to paddle anyway. Several people had rented boats. For two people, it was the graduation paddle for their basic sea kayaking class. We all had driven more than an hour to get there.
Bob thought he could modify the paddle to eliminate the crossing, where the threat of a lightning strike would be greatest. The wind had died down, the clouds seemed to be parting. Cooler heads prevailed, however, and instead of getting in the boats as planned we went to a restaurant to give the storm time to move on. As it happened, the plate glass window of the Seagull Restaurant gave us a lovely view of the lightning storm, right where we would have been paddling. Loud thunder was so close that our coffee cups rattled. We canceled the trip completely.
The Lesson of Sunk Costs
Sunk costs cannot change, no matter what you do next. That money, time, or effort is already gone.
These were our sunk costs:
- Renting kayaks and the hassle to go get them
- Getting up at 6:15 a.m. on a weekend morning
- Driving to Fair Harbor, Washington
Our alternatives were to:
- Take the trip exactly as planned
- Circumnavigate the islands and then reassess the crossing
- Wait to make the go/no-go decision until we had better information
- Cancel the trip and head for home at 9 a.m.
Relevant costs are costs that vary depending on future alternatives. The only relevant costs were the impact of a delay (on current, tide, or predicted weather) and the risk of injury or death. Gee put it that way and we would have been foolish to get in the water.
The Pressure’s On
Sometimes you feel pressure that leads you to an unwise decision. Bob felt bad that many of us had traveled for more than an hour, rented boats, and counted on this trip to graduate from our class.
The emotional pressure of sunk costs is extremely difficult to overcome. If your boss doesn’t understand this concept, you may feel you have to justify what’s already been spent by moving forward.
Remember the relevant costs and refuse to be influenced by sunk costs. Make a list of only those costs that will vary depending on future alternatives. Do the math. Show your calculations and reasoning. Then lead your team to the best decision.
Linda Keith is a CPA who provides consulting and training for financial institutions and is a frequent presenter at business and banking conferences. Learn more at LindaKeithCPA.