Monday 27 July 2015

Sunk Costs; let them be

In life as in business, we make crucial decisions on a regular basis. These decisions affect the way in which we can maximise our time, energy and profit. But we don’t always make the right decisions for the right reasons.

Sunk costs are about the value we place on decisions made in the past, which affect the decisions we make today. The argument being that our decisions are skewed by the emotional investments we stockpile; the larger the total retrospective investment, the harder it becomes to abandon it. 

To make effective decisions, we need to ignore the accumulated value and consider other options, such as replacement and abandonment. To exemplify:-

Three problems, three solutions 

  •  Your current Smartphone cost you £159 two years ago as an upgrade and can no longer support any new apps or o/s upgrades. It’s in great condition. You have all the contacts backed up to your laptop and can transfer them with a bit of head-scratching work to any other phone. You use this phone daily, for business and pleasure. A new improved version is £250 as an upgrade, plus you get a year’s warranty and a cheapo, faux leatherette case in the bargain.

Do you buy the upgrade or stick with the old phone until you can no longer use it? 

You should take the upgrade and put the old one in a box. It could always be an heirloom or similar one day (or not).

  •  Your current car has 83000 miles on the clock, two worn tires and a dodgy gearbox. You use it for your daily commute to your office and for recreational purposes.  A major service interval is also looming on the horizon. Your friend offers you £4500 for the car, but you know it’s worth at least £6000. He knows about the car’s history.

    A newer version of the car is £10000. It’s six months old and comes with a year’s warranty.  It’s not the exact spec as your current car, but is in mint condition with 12000 miles on the clock.  You have the money to buy the car.

Do you keep your car or buy a new one?

You should buy the new one and sell the old one to your friend at his value. You could ask for more, but in the light of its problems, he must be an optimist to want it. Don’t forget to empty all door bins and the boot before passing it on.  

  • Your executive leather briefcase is worn out. You use it daily for business and it’s the first thing on your desk in any meeting. The locks are failing, the inner pockets are tearing at the seams and the exterior is now in need of some patching and retouching. It was given to you as a gift on your birthday by your family eight years ago. It cost them £450. The cost of repairs will come to £135.

    You walk past a newer version on display at the local shop. This also has a USB charging provision and waterproofing. It costs £750. The internet returns the same price deal. It has a two year warranty.

Do you get the briefcase repaired and keep it or do you replace it?

Buy the newer version of the briefcase.  Ask the family to wrap the old one up in bandages, and place it in storage. 

In effect, once you get past the fact that hanging on to an  item or even entire business beyond it's useful life can be detrimental to you, it makes the decision making process to dispose of it, considerably easier to implement. As already iterated at the start, it is our emotional investment in something that can be harder to let go of. But that doesn't compensate for  losses we may then suffer now and moving forward, where rationality is a better paradigm to adapt in order to survive and thrive.

So the next time you face a decision that involves dealing with something that has reached the end of it's useful life in a business context, remember that the value you place on it now, is based entirely on the value it has accumulated for you based on emotional as well as financial metric. The former isn't as easily quantifyable as the latter, but it's the one thing that needs to be assessed with care, when growing and moving forward in a business capacity.


For writing/ consultancy related enquiries , email here

LINKS TO MY :-   Twitter     

No comments:

Post a Comment