18.4: Sunk Costs

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At the beginning of September, you were really excited about OU’s prospects in football, and when Wilbur suggested that you should each spend $100 for good seats at the OU-Texas game in Dallas, you enthusiastically agreed. But now it’s October, the team hasn’t done very well, and you aren’t very interested in football anymore. Besides, it’s still very hot, you’ve had a cold, and you’d really prefer to stay in Norman this weekend and relax. But then you remember that $100. It’s too late in the day to sell the ticket to someone else, so if you don’t go to the game you’ll have wasted it. Better get on the road.

We often reason this way, but is it rational? Your $100 is already gone. Your overall financial situation is just the same as it would have been if someone had stolen that $100 right before you bought the ticket. If that had happened, it wouldn’t justify going to the game. So how can the fact that you have sunk $100 justify going now? It won’t bring your original $100 back. So how can it justify spending more money (for gas and food in Dallas) to do something you won’t enjoy?

The $100 Wilbur paid is known as a sunk cost. A sunk cost is money that has already gone down the drain. Since it is gone, it doesn’t make sense to continue with a plan you no longer believe in simply because you sunk money in it. Following through on the plan won’t bring that money back; it will only lead you to incur further costs (e.g., paying for gas and food on the trip to Dallas and having a miserable time doing it). Instead, we feel like we must carry on to justify our initial expense.

Even people with a lot at stake often honor sunk costs. Wilma is the CEO of a large company that designs and manufacturers attack helicopters. Her company has spent $700,000 designing a new helicopter when it learns that a competing company has already designed a helicopter with the same features and has just landed a contract with the Pentagon. There won’t be any other market for her company’s helicopter. Should Wilma authorize another $200,000 to finish the design project? If she does, she is honoring a sunk cost.

Sunk costs also operate at the national level. When a country is involved in a war that they aren’t winning, one of the justifications typically offered to keep fighting, even when it can only lead to further disaster, is that “if we don’t, all those soldiers who died will have died in vain.”

Honoring sunk costs isn’t always a bad thing to do. Sometimes it is important to us to follow through on a plan or commitment because we want to be the sort of person who finishes the things they start. And in other cases, we can turn our tendency to honor sunk costs to our advantage. Many people reply on the power of sunk costs as a means of self-control, paying a good deal of money to join a health club or buy a home treadmill. Their hope is that the thought “all that money will go to waste if I don’t go work out” will make them more likely to get to the gym.