Why Not to Count the Sunk Costs
A few weeks ago, a reader submitted a question via Twitter, asking for advice “regarding an economic perspective on when it’s time to end a relationship.”
Needless to say, I’ve been avoiding answering this question, but here it goes.
I remember shopping with my friend who found a cookbook on sale, and she had been wanting to get for a gift. She grabbed it victoriously and proceeded to the check-out. It was Christmas time and the line was long. It was hot in the store with our coats. We had been in line about ten minutes and I asked her if she really wanted to stay in line and buy the book. She responded “well we’ve already waited, so I should stay!”
My friend wasn’t counting the opportunity cost of having to stand in line another 10 to 20 minutes. The time we had already spent in line was gone forever. Those minutes were, as they say in business, a sunk cost. But that doesn’t mean we had to forgo even more time, just because we had already given some time.
We were called to assess our new situation. The store is crowded and the line is moving much slower than we thought it would. Our coats are getting hotter and our bags are getting heavier. She had to re-calculate how much more time in line the cookbook was worth.
Only she knows how much it was worth to buy the cookbook and give it as a gift and only she could make the calculation of how long it was worth waiting for. But like the rest of us, she is called to be the best possible steward of her time. And we left the store, without the cookbook.
Sunk costs are the expenses and opportunity costs already incurred in the pursuance of a project. For a business, these expenses have already been spent and the transactions recorded. The money is gone, and it’s not coming back.
My undergraduate finance professor used the example of a relationship when lecturing on the topic of sunk costs. The way I remember his example going was something along the lines of,
So you’ve been dating this girl for five years. You were high school sweethearts, and you came to college together. You have invested not only the years into this relationship, but a lot of money on dates and gifts, and have changed the entire trajectory of your life by choosing to come to the college she got accepted to, instead of any other school. You have known for several months, maybe even the last few years, that you have to break up with her for whatever reason. You have been ignoring it, you have been denying it, and you stay in the relationship because so much of your life has been invested in her. But that time, and that money, and those decisions are all sunk costs. The net present value of the relationship does not justify the continued investment.
My professor was using the story of an ill-fated relationship to make his point about sunk costs because it is a sad story to which most of us can relate.
Net Present Value (a topic for another post!) in business is the present value of all expected future cash flows. In a relationship, it may be the value of the expected future relationship. Do you think the relationship will continue to be antagonistic? Do you think your boyfriend will continue to be a drag on your emotional stability? Do you think you will marry her?
If the net present value is not worth the continued investment, you shouldn’t continue with the project (relationship). You can’t let the sunk costs hold you down.
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