What is a sunk cost? It is a cost of a decision to buy or lease something made in the past. It could be a past decision to hire a person. This would have an ongoing cost attached to it. It could be a past decision to buy a vehicle or piece of equipment.
There are 2 main things to look at when dealing with sunk costs.
Number 1 – your past decision does not count when new factors come into play.
What do I mean? Let us look at an example. A personal one.
You have booked a trip to Italy 6 months ago. You paid a $6,000 non-refundable deposit.
Three months later the cities you plan to visit are hit with a deadly, contagious virus. Do you risk going? That depends. It depends on how much risk you are willing to take!
There may be additional costs if return flights get canceled. There are the huge costs of lost work or business time if you catch a vicious virus. That could get really expensive. You look at those costs compared to the $6,000 lost deposit. You think, “no, I cannot afford to be quarantined for weeks or months.”
Number 2 – consider all the non-financial costs in making your decision. Your health for one. Is it worth the risk of dying for a holiday? How much fun will you have quarantined in a windowless, white room for endless weeks?
Lastly, can you relax on your holiday worrying about the things that could happen. Maybe they don’t happen; yet your entire holiday is spent on edge!
Rule #1 – Sunk Costs are Finished – Don’t Count Them
The word “sunk” in “sunk costs” is the key word. It is sunk, finished. It cannot be changed or refunded.
You may be thinking – if it is sunk, and I cannot change, why not make the best of the situation? Grin and bear it.
You will not just “grin and bear it” because you found a better way that will cost less.
Another example. About 20 years ago we took on a new client. They were a small manufacturer. They had purchased an “award-winning” software made for “small manufacturers”. It was expensive. It was over-sold. Some of the modules had not been completed yet. It was like buying a car after test-driving the prototype. You get the delivery of the production car. You find out it doesn’t have a transmission.
My client had sunk over $100,000 into this new software. It was not working, and it would never work properly. The costs were going to increase.
We offered a cutting-edge solution with a proven, inexpensive software. Our software had a manufacturing module built-in. One that actually worked!
This leads us to…
Rule #2 – When Making a Decision Compare ONLY Future Costs
When the business owner made the decision, he did not add in the $100,000 invested. He did not say, “we are already into this for $100,000. Let’s just keep going and somehow make it work!”
He only compared what the future costs were going to be and compared those. He compared the costs of both alternatives. We looked at how much it would cost the business to go with our solution. He then looked at the costs to complete the installation of the crappy software.
One big cost was that it took much more labor to manage the bad software.
This leads to…
Rule #3 – Evaluate the Non-Financial Costs
He remembered to include the hidden, non-financial costs. In fact, they were the biggest factors in his decision.
- The lack of good reports
- The way the modules did not interact well with each other
- The stress on his Team
- The distrust he would have with his reports and numbers
The trick is to act fast…
Rule #4 – Avoid Delays – It Will Cost You More
The tough part of this process is moving fast. It is easy to hang on to the past. We wonder how we got here. We can blame ourselves for bad decisions. This prevents action.
An example here is a relationship. Imagine your teen aged daughter comes to you. She says, “dad/mom, I have invested 2 years with my current boyfriend. He is mean to me. He borrows money and doesn’t pay me back. He dresses badly. And, he is rude. BUT I have a 2-year history with him. I have invested a lot of my precious time with him. He could change!”.
Which brings us to…
Rule #5 – Give up The Emotional Attachment to The Past
What advice would you give your daughter? Maybe you would tell her to give him one more chance. Let us assume she has given him a dozen new chances. He has let her down every time.
You likely would coach her to end it, wouldn’t you. The sunk cost of her time is over. She cannot get it back, and it is not a factor in her future. Her future looks miserable if she stays with him.
And that is a massive cost!
My client was thrilled with the decision to go with our solution. It saved him a lot of money. The reports we delivered amazed him. He could rely on them for his business decisions. He referred many clients to us. To this day he offers verbal testimonials for new clients.
He went back to the software company with the incomplete modules. He threatened legal action. They agreed to refund him a large part of the past costs.
He walked away from the unrecovered sunk costs. This was one of the best decisions he ever made.
Thanks for reading…