Sunk Costs

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Sunk Costs

Sunk Costs — When to Hit Eject

By Brad Aronson   |   Posted in: Entrepreneurship
Sunk Costs

I recently had coffee with a former intern. He’s halfway through law school, has had a couple law related internships and realizes there’s no way he wants to be an attorney. Yet, he plans to finish school, because of his sunk costs — he’s already invested a year and a half and a lot of money to attain his degree (not to mention his parents’ expectations).

Continuing with his law degree would be the normal course of action. How many times have you sat through a movie you disliked, because you paid for the ticket and you already watched half of it? How about staying in your job, because it’s what you went to school for and you don’t want to waste all the time and money you spent on your degree?

I invested about $200K in a technology solution. When it was 90% completed, it was very cumbersome and our clients were indicating that it wasn’t something they’d purchase. All indications were that this was unlikely to work. Yet, we continued our development because we had invested so much money and we only needed to invest about $20K more. Like investors who keep buying more stock as a company plummets, I wanted to leverage my sunk costs — what I’d already invested. So I wasted more.

This all relates to sunk costs.  These are investments you’ve made that you’ll never recover. If all of us were rational (which I’m certainly not), sunk costs wouldn’t be a factor in whether or not we invest further in a project. It doesn’t matter that we spent $200K on a technology and we only needed to invest a little bit more. Same thing for the year and a half invested in school.

This is much easier written than done, and, of course you need to be in an environment (or create one if you’re a manager) where admitting a mistake and making this type of change is acceptable. This is hard. In some workplaces, probably impossible.

What’s easy is to make sure we constantly evaluate why we’re personally staying the course. If we’re only moving forward because of how much we’ve already invested, it may be time to make a tough decision — to quit.

What do you think?

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  • mderins

    I agree with everything you said outside of the investing aspect. It’s actually important to invest in small pieces of the whole intended investment. Should the initial investment go down on a company with good fundamentals et al, one should continue to invest and view the shares as being on sale.

    • http://www.bradaronson.com/about/ Brad Aronson

      Great point. If you determine you are going to invest $10K in a company, you can start with a $3K investment and then invest more if the company’s stock price decreases. Of course, you need to make sure you still think the company is still valuable when the price drops. And, you have to be prepared that the stock could also go up. Lastly, once your intended $10K is invested, you need to be careful about investing more money if the stock continues to drop. This is actually how I do my equity investing — dollar cost averaging over time. Thanks for the comment.

  • joe

    I think most of us face this dilemma some time during our life. The hard part is recognizing that continuing would not be economically or emotionally feasible and having the fortitude to stop.

  • Katy Friedland

    I guess it all comes down to being flexible and honest with yourself- not an easy thing to do!

    • http://www.bradaronson.com/about/ Brad Aronson

      Right. Easier said than done. Thanks for the comment.

  • Julie

    The hardest part is not knowing when to throw your hat in the ring, but in knowing when to bow out while you still show intellect and discernment in the process. Pride beyond good intuition and logic as well as “having to be right” aren’t the best motivators. Going down with the ship as a good character trait and behavior only really matters when you signed on as the captain of the vessel.

    • http://www.bradaronson.com/about/ Brad Aronson

      Well said. Thanks for the comment.

  • Kim Benjamin

    Good post, Brad. It also reminds me of when I can’t bring myself to sell a stock that is going down even when I know it’s best. There is something in us that wants to at least ‘break even’ in everything we do.

    • http://www.bradaronson.com/about/ Brad Aronson

      Thanks Kim. Stocks are funny. It’s hard to sell when it’s going up, because it may keep going higher. And, as you point out, also when it’s going down. I appreciate the comment.

  • http://www.webbmfg.com Steve

    That’s a hard one, as an inventor, I have spent time and or money on an idea or project that I have had to pull the plug before it was done. At the same time I have seen ideas that seemed weak or on a not working path only to discover that it turned out better than I thought it would. For me the answer is to leave your personal emotions out of it. A good inventor has to be able to walk from some ideas only to do another. The person who makes their effort or money “personal” are often the ones who get way in over there heads. The sunk money is a sucker punch. Ask for advice from people who are not your friends. they may tell you the truth, and then make your mind up and pull the trigger.

    • http://www.bradaronson.com/about/ Brad Aronson

      Great points. It is so hard to make the decision about quitting after you have started and already invested time or money. Perhaps choosing when you will stop investing in a business and choosing the metrics that have to be met to continue investing should be done before you invest a single $. That way, you’ve made the decision before you become emotionally involved. It won’t hold true in all cases, and it’s still hard to follow when you have to make the decision to pull the plug, but worth a try. Thanks for the comment.

      • http://www.webbmfg.com/ Steve

        your right on point. that is exactly what we do now. We set the “go or no go” bar now with a set date. We look on that date and if we are meeting the goals we set we push foward. The large companies do it every day. They set the numbers and if the division is not hitting them, their gone. No if, and or buts, just gone.