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VIEWPOINT: Sunk costs

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“When making decisions, only incremental costs and benefits should influence your future choices …”

Most of the readers of this magazine would have, at the very least, done some kind of elementary management accounting course at university where they would’ve learnt about sunk costs.

So we know that these sunk costs are completely irrelevant to decision-making, but do we actually ignore them when we make decisions?

I recently bought a new book by a South African author which has been well received internationally. The idea for the story is great and I really wanted to like the book, but four chapters into it and I just couldn’t anymore.

Almost every sentence contained a simile such as “her piercing eyes were as blue as the deepest ocean”, which becomes painful and laborious to read (in my and Stephen King’s opinion). Just get on with the story! I kept on feeling like I had to finish the book. I’d paid for it and I’d already read four chapters (I had the same conversation with myself after the second and third chapters). But then I realised: it was a sunk cost! Regardless of whether I finish reading the book or not, I’ve already paid for it.

When making decisions, only incremental costs and benefits should influence your future choices, yet research shows that when we are invested in something (whether it be emotionally or financially), we find it more difficult to give up on that investment.

Furthermore, the larger our past resource investment in a decision, the larger our predisposition in later decisions. That is, it would be more difficult to put down the book after reading four chapters than it would’ve been after reading only two chapters.

Think about how difficult it sometimes is to terminate a project that isn’t profitable just because you’ve already invested so much into it.

Or feeling obligated to attend every rugby game just because you’ve bought season tickets, even if you don’t feel well and would prefer to stay at home and watch it on the couch? And here’s my favourite: you make a phone call and hear the recorded voice say, “Please stay on the line, our operators are currently very busy.”

Instead of putting the phone down and phoning back when they’re perhaps less busy, we rather stay on the line as we’ve already made the call. Sunk cost!

If you’re making a decision because you’ve already done or paid x, y and z, you’re making a decision based on a sunk cost. Rather make a decision because it will benefit or save x, y and z. Think of the future and don’t be weighed down by the past. ❐

Author: Gizelle Willows CA(SA) MCom Finance is a Senior Lecturer in Financial Reporting at the University of Cape Town