Sunk Cost

  • What is sunk cost?
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What is sunk cost?


Definition of sunk cost

Much like a shipwreck, a sunk cost (by definition) cannot be recovered. Sunk costs are inevitable in business. And, because they cannot be recovered, they should not be included in any future budgets.

So, what are some common examples of sunk cost?

For one: equipment. Office equipment, like printers, often need replacing after a few years. At this time, the money spent on the old equipment is deemed a sunk cost.

Sure, some of it may be recovered if you can sell off some parts. But all the money that was spent on it initially is sunk.

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Or, let’s say a SaaS company invests in usability testing for a new platform feature. After launch, the feature is largely ignored by users, and no additional sales resulting from the development. 

In this case, all the money invested in researching the feature would come under sunk cost. And, in this instance, the worst thing you can do is pile more money into trying to reverse the financial loss — a mistake known, to some, as the sunk cost fallacy.

What is the sunk cost fallacy?

Because business leaders can be risk-averse in their decision-making, many fall foul of the sunk cost fallacy — that is, the belief that further investment will eventually reverse the losses from sunk costs.

Looking at our SaaS company, with the failed new platform feature: they may think that researching and adding further features will eventually lead to them recouping the sunk cost of the initial research.

This is not the case. The money initially spent is gone — sunk — and should not be factored into future decisions. 

The best course of action would be to realize that customers like the platform the way it is and not risk increasing the sunk cost of researching further, unwanted additions.

General FAQ

How to calculate sunk cost?
To calculate the sunk cost of a piece of equipment to be replaced, find its current as-new market price. Next, try to identify how much the item is worth in its current state, which should be possible with a little online research. Subtract the current value from the as-new price to find the sunk cost. To calculate the sunk cost of a project, list all equipment and/or tools that can’t be sold or reused. Find the purchase price and its current value to identify depreciation. Then assign a sunk cost. Next, add up the cost of labor for the project so far. Combine this with the cost of unsalvageable equipment and the sunk cost of goods that can be sold or reused. The result is the project’s sunk cost.
What is the sunk cost fallacy?
The sunk cost fallacy is a misconception that investing in a project or product further will allow you to reverse losses and still come out on top. The truth is that money has already been lost and additional investment will fail to recoup it.

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