Sunk Costs Are Irrelevant

Estimated reading time: 1 mins

Do you manage expense? Whether you’re a manager, professional or freelancer, if you make decisions that involve spending money then you must ignore sunk costs.

This is the advice from guru Seth Godin.

Seth’s point is an important lesson: no matter what has been spent before, make the right choice going forward. Making decisions that are biased towards sunk costs are irrational.

Let me quote an example from Seth’s article:

You have two pieces of land. One you bought for $1,000,000, one for $10,000. On which one should you develop a gas station?

I know. The one that’s right next to the huge subdivision being put up, not the one next to the condemned shopping center. Does it matter how much the land cost to buy? No. Not at all.

In other words, don’t make a decision to throw good money after bad, but instead make the right decision based on current conditions.

Computer Room

If you’ve spent $10,000,000 on a IT system, and need to spend another $10,000,000 on it, but then a newer, better system comes on the market for only $5,000,000 that does everything you need – what should you do?

You should ditch the old one and go with the new.

Problem is, as human beings we don’t like to think we made bad choices. The guy who chose to spend $10,000,000 on the new system doesn’t want to be shown up. But who cares? Was that decision made with the knowledge that an even newer system would come along for just $5,000,000? Probably not. Making the decision to go with the cheaper system is the right thing to do, and no penalty should go with the choice.

But this is what happens – decision makers *do* throw good money after bad to avoid being exposed as foolish. But the fool is the one who doesn’t do the right thing with currently available information!

In the current economic climate, this is a reckless act of lunacy.

As Seth says: Ignore Sunk Costs.

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