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Sunk Costs In Your Business Case

The short version is: don’t! Here’s why…

Sunk Costs In Your Business Case

“After everything I’ve put into this project, I can’t give up on it now.” Ever heard yourself say this? Or replace “project” with “business” or even “relationship” and I’m sure you’ll easily answer “yes”.

Being sentimental about things or relationships we’ve invested in – money, time, or effort – can be endearing. Imagine how cold and meaningless life would be if we didn’t value what we put into our projects, whether it’s our business, staff, clients or even personal relationships. Maybe the symbolic value of that old family heirloom outweighs its high maintenance costs?

But there’s a place where sentimentality or loss aversion gets us into trouble. Especially for business owners and other decision-makers.

If ever you’re facing a major decision, whatever you’ve invested to date is irrelevant.

In the business case for a big disinvestment – ending a major project or operation – only future costs must be factored in green-lighting the decision.

Sunk costs – expenses incurred and which cannot be recovered – have no place in your cost-benefit analysis. In deciding to end an investment, we must compare only the future costs of keeping it going against the benefits it’s expected to yield. What we’ve spent is water under the bridge – it’s never coming back.

The only time a cost that’s already spent could be a factor is if you’re certain you can recover it. But our assessment of certainty is usually clouded by our irrational emotions:

- In taking steps to recover a bad debt, at what point do you realise you’re throwing good money after bad?

- You’ve invested thousands in a marketing campaign for a product launch, but it’s not gaining traction – when do you cut your losses?

- When you’ve paid for a big-ticket conference, but you've fallen ill on the day, how sick must you be to convince yourself that your debilitated attendance is not worth it?

- Do you over-eat at the fixed-price buffet because you have to get your money’s worth?

The most common dilemma I’ve seen business owners grapple with is when an existing project or operation is challenged by a replacement. It’s even harder to kill a project if it’s already produced some assets, like useable software or production machinery. But despite whatever has been produced, assuming projects A and B will yield identical benefits, the time and money already spent on project A are irrelevant.

To choose between finishing project A and starting project B, only project A’s remaining costs are relevant. If project B’s total costs are less than project A’s completion costs, the decision is simple: switch to project B.

When you’re deciding to switch from one investment to another – a project, a business, a key relationship – the only costs relevant in your business case are the future costs.