January 17, 2008

Are sunk costs really sunk? Sometimes.

Today’s highlight deals with Mr. Cowen’s description of sunk costs. I like it. For the record, the first time a professor explained the concept to me, I basically thought he was an idiot, because that was not what I had been taught. If I buy a ticket to a football game, I’m going. I don’t care if it’s snowing. That ticket probably cost upwards of $100, and I’m not going to waste it. No sir.

Honestly, I do give some credit to the concept. After all, if you have spent a small sum of money and it is now worthless for you to harvest the fruits of said investment, it’s probably better to just forget it and save yourself the worrying. Sunk costs have simplified many areas of my life, especially in areas like movie tickets where they are not so expensive that I need to be worried about walking out. I’m glad Cowen admits he does this frequently. I’d say I walk out of 30% of the movies I attend, so at least I’m not alone.

But the concept only goes so far, and it can’t be misunderstood. Once you talk about big investments, you’re putting more than just money on the line. Big investments lost could mean your reputation, especially if you let them go seemingly lying down.

An example of a misunderstanding of sunk costs: Let’s say a company puts down 10 grand on a new technology system, which will hopefully streamline business and save costs. Turns out, the system crashes on the first day, and the company won’t give the money back because the big boss didn’t buy a warranty (let’s assume he’s not getting the costs back).

Now what should the boss do? Say, “Oh well, that’s too bad the system’s broken and no worries. We’ll buy another one”? Only if he understands sunk costs the wrong way. Realistically, if he did something that stupid, or at least which would seem stupid to his employees, he would probably lose respect. After all, most people are ready and willing to complain and complain till they get their way. Trust me, I used to wait tables.

So the boss should probably talk to the company who provided the technology. At least I think so. He should definitely give them a piece of his mind, instead of lying back and adopting the non-chalant, laid back attitude that the idea of sunk costs can encourage if misunderstood. This way, he at least saves face to his employees, and potentially saves the business from some bad situations that could have resulted from a loss of respect.

A lot of people might think that given the idea of sunk costs, we should always let go and just let everything slide. If the weather sucks, forget the $3,000 Dallas Cowboys playoff game. I think I understand what Cowen is saying though, and how it relates to my initial understanding of sunk costs. If it’s not a big cost in the first place, and you place a high cost tag on stress, then forget it for the sake of the pigment in your hair. If it’s a big cost, it might behoove you to at least try to recover the costs, even if the experience you encounter isn’t quite worth the price you initially paid for. Respect and pride have a lot to do with the way things work, and I believe rational people act upon these impulses just as much as they do upon dollars and cents alone.

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