Sunk costs and elephant spray
A few years back, in those dark days of power cuts, we bought a generator for the office. Everybody was buying them at that time so we had to wait for it to be imported. By the time it arrived and was installed the power cuts had pretty much come to an end. We’ve had about two short ones since then, so the genny simply switches itself on every Tuesday and runs for 15 minutes to recharge its battery and that’s all it does.
Does this bother us? All that money just for that? Not at all, it’s like the elephant spray that keeps them away from our house in Fourways – as long as we don’t get elephants, we don’t mind spending money on the spray!
Which brings me to sunk costs. Here’s an example. My wife and I have booked and paid for the flight and accommodation for a holiday in New York in February this year. Crazy I know, but it’s her birthday and she’s never been to the States. Now, she told me this morning that the temperature over there is -40 (interestingly that’s the exact temperature at which Celsius and Fahrenheit are the same). Flights are cancelled and they are saying don’t travel unless it is essential. Should we go?
One argument (the most common) is “But we’ve spent all that money, we have to go!”. No! no! no! The money spent is spent, gone, bye-bye. It is what we accountants call a sunk cost. Whether we go or not the money is gone so the spend should not in any way influence our decision, or in accounting speak – when evaluating the cost of an investment decision never include money already spent.
This is not an easy concept to take fully on board. We once owned a cabin in an exclusive getaway resort. The members ended up in a legal battle with the developer and we all had to keep chipping in for the legal fees. My wife and I walked away from the whole messy business leaving the cabin and writing it off in our minds. It was, after all, a sunk cost – the decision itself didn’t cost us anything.
It’s easy to read the logic, but it is far more difficult to apply it..
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