What Is a Sunk Cost and the Sunk Cost Fallacy?

Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. A program manager is someone who is responsible for leading a number of interdependent projects to achieve strategic objectives. The Program Manager focuses on overall benefits realization and achieving organizational goals rather than managing short deadlines and individual deliverables.

  • The sunk cost fallacy is when individuals or businesses follow through on a decision even when they know the expense may be higher than the potential benefits.
  • While these sunk costs remain important data points, the Project Manager must exclude them from the analysis of alternatives for a decision.
  • Opportunity cost analysis also plays a crucial role in determining a business’s capital structure.

Sunk cost, in economics and finance, a cost that has already been incurred and that cannot be recovered. In economic decision making, sunk costs are treated as bygone and are not taken into consideration when deciding whether to continue an investment project. A sunk cost is always classified as a fixed cost, though some fixed costs are not classified as sunk costs. A fixed cost that is a sunk cost cannot be recovered, as is the case with customized equipment for which there is no resale market.


If you don’t, you run the risk of spending even more money that you’ll never recover if economic conditions don’t improve fast enough. The dilemma can be framed as one of certain loss versus uncertain success.During the U.S. recession many homebuilders chose to keep working, what is ancillary revenue assuming this economic recovery would mirror past experience. It didn’t and many of them failed because there has been no sustainable rebound in the real estate market. In retrospect, they would have been better off ignoring their sunk costs and cutting their losses.

A small business leadership team choosing to continue sunk costs is a reflection of poor financial and business judgment. It’s important to reflect on the type, the amount, and the duration of sunk costs. Let’s dive into sunk costs, including a definition, types of sunk costs, the sunk cost fallacy, and how to avoid them whenever possible. Also known as retrospective cost, a sunk cost is a financial investment that cannot be recovered. The sunk cost fallacy states that making additional investments or commitments is justified since some resources have already been invested.

What Is a Sunk Cost Fallacy?

Sunk costs are expenses incurred to date in a project that are already spent and as a result cannot be recovered. Sunk costs are fixed and do not change irrespective of the levels of productivity of a project or operation. Sunk cost examples include rent, subscription fees or hardware. It is generally advised to ignore sunk costs, as nothing can be done about them in the future.

What is the difference between sunk costs and opportunity costs?

To make this decision, the firm compares the $15 additional cost with the $20 added revenue and decides to make the premium glove in order to earn $5 more in profit. The cost of the factory lease and machinery are both sunk costs and are not part of the decision-making process. Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another. While financial reports do not show opportunity cost, business owners can use it to make educated decisions when they have multiple options before them. The last major component of the sunk cost dilemma is opportunity cost. Opportunity cost is the concept of what you give up by choosing one option over another.

What is sunk cost?

The money is already spent and cannot be included in your future budget. Sunk costs can influence decision-making by creating emotional attachment and the desire to recoup past investments, leading people to make decisions that are not in their best interest. A real-world historical example of the sunk cost dilemma can be found in the construction of the Sydney Opera House in Australia. This approach should reduce the risk of the sunk cost fallacy in your projects and also assist with streamlined decision making where needed.

This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital.

If you don’t finish it, you think you’ll have wasted all of that energy. You decided to write a book, and five years later you’re still writing it. The topic that once interested you no longer does, and it’s a struggle to get yourself to sit down at your desk and start typing. But you’re two hundred pages in and have dedicated hundreds of hours to researching and writing your novel. Get up and running with free payroll setup, and enjoy free expert support.

Sunk costs are an everyday financial occurrence and do not only affect businesses. For instance, when you purchase a washing machine or new phone, it will eventually need replacing. At that point, the amount you paid for the old washing machine or phone is considered a sunk cost. People try to avoid unnecessary expenses by considering warranties and trying to estimate how long the item will last.

Variable costs are only relevant in the decision-making process since they change depending on the decision made. The sunk cost dilemma may lead to irrational decision-making where individuals or organizations make choices that defy logic and reason. Instead of assessing the current situation objectively, they are influenced by past investments. People often fear that if they abandon a project or decision with substantial sunk costs, they will regret their prior investments. This fear of regret can be a powerful motivator to continue down an unproductive path.

Because the price falls as production increases, the marginal revenue is less than the price. The marginal revenue curve has twice the slope of the demand curve and the same intersection with the vertical axis. Purchasing a car is a sunk cost as the full amount cannot be recouped or saved and depreciates over time.

The manufacturer can sell the basic model and earn a $20 profit per unit. Alternatively, it can continue the production process by adding $15 in costs and sell a premium model glove for $90. For example, you ordered takeout for dinner, but could only finish half of the meal. To justify the money spent, you may feel the need to eat the rest of the meal and not let it go to waste. This sense, despite the additional cost of a potential stomach ache, is considered the sunk cost fallacy. Although sunk costs can act as distractors in decision-making, it does not mean they do not matter or should not be considered.

Sunk costs are excluded from a sell-or-process-further decision, which is a concept that applies to products that can be sold as they are or can be processed further. No, sunk costs should not be considered when making business decisions because they are irrelevant to future costs and revenues. Only future costs and revenues should be taken into account when making business decisions. Sunk cost refers to money which is spent and cannot be regained. It is typically used in the context of businesses and business bookkeeping.

Loss aversion prompts individuals to continue making poor choices because of the fear of losing. This is a tendency to avoid making losses since the ideology of losing is psychologically powerful and painful. Sunk cost fallacy can lead to missed opportunities as people become more reluctant to pursue new ventures and cannot abandon or pivot from what they have already invested in. Financial responsibility does not mean avoiding these expenses but knowing when and how to mitigate the damages. The dilemma then arises whether to continue painting the same color as you have already purchased the paint and completed two rooms or to buy a new color that meets your preferences.

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