Question

What is meant by a sunk cost? Give examples of typical sunk costs for an IT project as well as examples from your personal life. Why is it difficult for people to ignore them when they should?

Answer 1

Sunk costs are also called past cost or dead cost. This is the cost that has already been expended and we cannot recover these costs. While making a business decision, sunk costs are not considered as sunk cost remains the same irrespective of the decision.

Sunk costs for an IT project - A large hospital wished to implement a secure mobile check-in application. Time and money were spent in laying out the scope of the project and selecting a vendor. Post-selection, the vendor started implementing the project however 6 months down the line there is no progress and hospital faces a decision to continue with the project of building the mobile application. In this project sunk costs are - Cost of procuring and selection of vendor & Payments already made to the vendor for building the mobile application. These costs cannot be recovered irrespective of the fact if we continue the project Or shelve the project.

Sunk Cost in personal life, Example - You bought a coupon for attending five Yoga Classes at a discount from Groupon. However, you went for 1 class and did not like it. Irrespective of the fact you decide to continue or not for another 4 classes, you will not get the money back. Another example would be paying a gym membership for 12 months and then deciding after 2 months, whether to continue or not. The membership paid is a sunk cost.

It is difficult to ignore the sunk cost trap as one feels that we have already spent so much money on something and continuing to putting money may lead to recovery. It is similar to a gambling problem. For example - Once you have spent on yoga classes, you may wish to attend even if you do not like because you have already spent on it.

Sunk costs can lead to lT project delays and bigger project overruns if the company keeps considering the sunk costs. People should be rationale and ignore sunk costs while deciding a future course of action or making a business decision. For example - Even though you cannot recover money by not attending the rest of the yoga classes, you can save time and do something else by not attending the classes, something that you like.