Sunk Cost
A sunk cost is a cost that has already been incurred and cannot be recovered. In economic analysis, sunk costs are irrelevant to current and future decisions, because whether to continue a course of action depends only on the costs and benefits that lie ahead, not on resources already committed and irrecoverable.[1]
Definition
A cost is sunk if it cannot be recovered once it has been incurred. Common examples include money spent on research and development, advertising, or specialised equipment that has no resale value. Because such costs cannot be avoided or recovered regardless of what is decided next, they should not influence rational decision-making.[1]
The sunk cost fallacy
Despite the logic of ignoring sunk costs, people frequently allow them to influence their decisions—a tendency known as the sunk cost fallacy. This occurs when individuals or organisations continue investing in a project because of resources already committed, even when continuing is not justified by the future benefits. A classic example is continuing to watch an unenjoyable film because one has already paid for the ticket.[1]
Relationship to other cost concepts
| Concept | Description |
|---|---|
| Sunk cost | A cost already incurred that cannot be recovered. |
| Opportunity cost | The value of the best alternative forgone. |
| Incremental cost | The additional cost of a particular decision. |
| Avoidable cost | A cost that can be eliminated if an activity is discontinued. |
In decision-making, only avoidable and incremental costs, together with opportunity costs, are relevant; sunk costs should be ignored.[1]
Implications
The concept of sunk cost has important implications for business strategy, where managers are often advised to "ignore sunk costs" and to base decisions on expected future cash flows. It is also relevant to public policy, where governments may persist with failing projects because of the political cost of abandoning investments already made.[1]