Making the right decisions is a key part of business management. Should you invest on that equipment? should you hire that new employee? Does it seem right to pay for the proposal the marketing company sent you? These are just some examples and I am sure you can find many more.
One important concept that needs to be understood in decisions making is that of “sunk costs”.
Sunk cost are those you have already incurred and you cannot get them back. As the saying says sunk cost are like water under a bridge.
Why is this important? its because as humans we tend to include the value of these costs in our every day decisions. Instead of looking at it in a logical manner and understanding that the money you spent in the past is gone you cannot recover it and it should not influence your opinions in the future.
Here is a simple example. You buy a used car for $3000 dollars you feel happy about your purchase because you got a running car for a very decent amount of money. After a couple of months you find out a huge problem in the transmission, yikes the mechanic tells you it will cost you $4500 dollars to repair it. What do you do? do you spend the money to repair the car or do you cut your loss and go buy another car instead.
We tend to want to stick with our old decisions based on the investment we have made, if we spent so much time and an effort in building that career or business why would make a change? In some sense we believe that previous effort has future value but it really does not.
Here is another great example:
You buy a ticket for a vacation in Cancun for $1500, non refundable ticket. Two weeks before the vacation you get an email offering a better vacation, a beach facing room with all the amenities for $750, What do you do? do you stick with the old vacation or do you take the better one?
It is very natural to cringe and say well you have already spent the $1500 might as well take that one. But instead you should think about which choice will bring you the best experience in that moment with out considering the past.
It is a human condition to always look at our losses and carry these on in case we need to make another decision. But these lose have already happened in the past, you cannot change them and they should not impact your future decisions.
If you want to read more about sunk cost you should check out this post You are not so smart