In economics and business decision-making, a sunk cost is a cost that has already been incurred and cannot be recovered. Sunk costs (also known as retrospective costs) are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken.
In other words, the more one puts into a project, the less one is inclined to pull out of it. If a parent has invested three years tuition at what has turned out to be a mediocre college at which his daughter has performed poorly, he is reluctant to give up on the school and the child, and pays for another overpriced and unproductive last year. If a manager has spent three years in developing an employee (business, sports, entertainment) and he has turned out to be far less of prospect than initially envisaged, he has a tendency to keep the employee on hoping that another year, perhaps under improved conditions, will produce initially expected results.
To counter this, economists have encouraged the ‘bygones principle’.
They stress the "extra" or "marginal" costs and benefits of every decision. The theory emphasizes the importance of ignoring past costs and only taking into account the future costs and benefits when making decisions. It states that when making a decision, one should make a hard-headed calculation of the extra costs one will incur and weigh these against its extra advantages (Wiki)
Yet the idea of giving up on an investment when there is even the slightest chance of recouping it is compelling. It is very difficult to let bygones be bygones when the bad investments of the past reflect badly on one’s intelligence, insight, acuity, and business sense. Managers have more to gain by turning the ship around than just economic returns.
Silicon Valley has always been very good about ignoring sunk costs. Risk-taking is central to innovation, and a high rate of failure is endemic to the industry. Yet because the rewards for successful innovation are so great, managers are willing to invest millions which they know are likely to be lost. As importantly, they know when to pull the plug, forget sunk costs, and move on to the next promising idea. The industry ethos of risk, failure, and loss as contributing factors to success challenge the traditional paradigm of sunk costs.
Sunk cost thinking is not exclusive to business. Most of us base our decisions on this economic principle all the time. If we have spent time on a long and difficult trip to purchase a particular item only to find it unexpectedly out of stock or the wrong size or model, rather than limit opportunity costs and quickly return home and back to productive work, we stay at the Mall hoping to find something else that will justify the wasted trip.
If an employee has spent days researching a paper to be presented at a company seminar and found that the original idea was far less unique than originally thought, rather than scrap it and move on to something more appropriate and promising, he chooses to ignore the obvious and to convince himself that he can work around the nettlesome arguments that contest his hypothesis or cast his own argument in an alluring way which will deflect inquiry. He runs the risk of criticism to justify sunk costs.
None of this is new; but few realize how much and how often they apply the economic principle of sunk costs to personal decisions.
A colleague (call him Henry Watkins) found himself in a bad marriage and had known so for a long time; but at each stage of his progressively deteriorating relationship, he considered but rejected the idea of divorce. He and his wife had invested so much in marriage, children, house, and home that neither one could bring themselves to separate. They each considered divorce after ten years, then fifteen, then twenty; but since sunk costs increase the longer the term of the investment, separation – economic, financial, personal, and emotional – became more and more unfeasible.
After twenty years the house bought for $250,000 in a down market was now worth over a million. The children were in elite private universities thanks to the couple’s combined incomes; and their place in the community consolidated by their joint contributions to neighborhood improvement, schools, and churches.
Henry looked at the not inconsiderable wealth he and his wife had amassed thanks to their professional skills, her financial acumen, and his timely purchases of real estate and Western land, and realized that disentangling himself from the now complex web of joint investments would be almost impossible and outrageously expensive.
His wife had made her peace with their arrangement. Their now diffident personal life was of little consequence given her increasingly influential and remunerative positions in business. She loved their children if not her husband; and if she was careful to avoid contentious issues and tip-toe around minor infractions of the domestic contract, she could carry on with little second thought to what had become an essentially loveless marriage.
All marriages lose their luster, she argued to herself, so why not ours? Marriage was never supposed to be about love but children, family, and economic and social stability, so why let some lack of accommodation get in the way?
Henry took a different tack. Love – or at least sexual satisfaction – was supposed to be a part of marriage, and although love did naturally turn tepid after many years of sharing the same bed, it should evolve into something more subtle and permanent.
Yet his marriage was not only tepid or even indifferent; but it was not progressing towards a more mature and deeper understanding. It had soured completely. There was no one thing that convinced him of the irretrievability of the marriage – no discovered infidelity, social miscue, or misguided treatment of the children. He simply discovered that his wife of twenty years was not the woman he thought she was. Apparently he had been seduced by her beauty, charm, with, and feminine allure and either missed or ignored her emotional and intellectual bindings. Not only were there no sexual juices flowing, whatever reserves of curiosity, emotional ambition, and surprise there might have been had dried up completely.
So rather than throw away the years of financial and personal investment in the marriage, he decided to complement it with what he called ‘collateral satisfactions’. Still a young man, he found that affairs with women were indeed possible, and for years he contented himself in a quite agreeable, clandestine life.
My Other Life, a fictionalized autobiography by Paul Theroux, spoke for him. One could lead parallel lives even if one was secretive and unannounced. In what had become a marriage of convenience, he was rarely suspect and never challenged. His wife may or may not have known about his infidelities, but in either case, she registered no reaction.
For her part, the sunk costs were less of a burden than for her husband, less imposing, and less permanently ‘there’. She took them as a matter of course. Not so much ‘let bygones be bygones’ but a conviction that no arrangement – no marriage, partnership, or collusion – would ever be ideal. Play the cards that you are dealt. They do not always end up as bad hands.
There were times when she had had enough and wanted out. She was not so daunted by the legal and financial complexities of an intimately conjoined marriage and knew that the legal costs, high as they would certainly be, would certainly be worth it. The idea of jettisoning the whole thing – husband, children, home, and community – was very appealing indeed; and she often envisaged opening a practice in Tucson or Salt Lake City and doing quite well for herself.
Yet it never seemed worth it. All that time, effort, emotional dues, physical strain were incalculable costs. They were nothing compared to the economic and financial costs that she and her husband had negotiated well enough to create a considerable treasury if not fortune; and that was saying something.
So both Henry and his wife soldiered on, prisoners of sunk costs but adaptable enough to make the best out of a lifeless marriage.
Eventually Henry, like most men, returned home. In his mind he had never left, a la Paul Theroux; but had retained a consistent fidelity to the institution of marriage if not to his wife; and that was saying something.
The story of Henry Watkins and his wife is as old as the hills. Uninteresting, unimaginative, and totally predictable and unremarkable; but that is what sunk costs do to people. Our innate conservatism – our niggardliness in fact – inhibit our freedom of emotional choice. Most men and women could easily leave a bad marriage just like the geeks of Silicon Valley move on after a disastrous enterprise, but few do. It’s those pesky past years, dollars, sweat, and tears that crimp their style.
Edward Albee famously noted that marriage – as horrible and penitential as it was – was the crucible of maturity. Only within its inescapable confines can one sort out oneself let alone one’s relationships with others. George and Martha (Who’s Afraid of Virginia Woolf) considered sunk costs as necessary, inescapable features of the past, investments in emotional discovery. The ending of the play is hopeful because George and Martha, emotionally, existentially drained have ‘cut to the marrow’. When there is nothing left, when the past has been exposed for what it is – inescapable and vitally necessary no matter how destructive – there is no place to go but up.