Sunk costs are those costs that occurred in the past and are therefore irrelevant to decision making. In business, when making decisions for projects, you should ignore previous spending.
This principle was followed by the Government during the ‘80s, when they scrapped the Nimrod patrol aircraft. Costs had spiralled to £1bn on the project, but this did not influence the decision to cancel it. Instead, the government purchased the Boeing AWACS, the one with the giant mushroom on its back. Many felt that the development should have continued. After all, £1bn had already been spent! However, economists would argue that the decision makers of the day were correct, the £1b was a sunk cost, thus irrelevant to the decision making process. We make such cost decisions daily. For example, you just spent £100 on an external hard drive to back up your computer data, then you discover the convenience of ‘Cloud Computing’ to back up, synchronize and access your files anywhere, for just £35 a year. Would you say: “But I have just spent one hundred pounds on the external drive, so I will continue to use it”, or will you ignore this sunk cost and make the rational decision?
Written by Viimi Limited and published in The Clifton Times August/September 2010.