Sunk Costs: Part 2

In the first installment, I flew over what sunk costs are and how they differ from the other kinds of costs you face in your business.

To recap briefly, economists and business courses make the point that sunk costs should not be taken into account when making decisions about new expenditures. The money is spent, it can’t be recovered and making new decisions that take past decisions into account can be unwise.

It can be an easy mistake to make. If you’re familiar with the construction business, and many of you AV pros are, remaining attached to sunk costs can lead to cost overruns.

Consider a scenario where you’ve paid $5 million for a new building in an industrial park, but for whatever reason the project has stalled and the building remains uncompleted. Now, for the sake of argument, the two hypothetical scenarios you face are to complete the existing building, only now, with new contractors it will cost another $5 million to complete. Or through another set of circumstances that have worked out in your favor, you have the opportunity to start fresh, in a different location and building brand new will only cost $3 million.

On paper, the decision is pretty clear cut. But in real life, it’s not always easy to disassociate yourself from the money you’ve already spent. It can be hard psychologically to write things off and face a loss on something.

Certainly with municipal projects this happens all the time. Politicians face even more scrutiny than business people, and often end up shoveling even more money at projects that were already overdue and over budget to begin with.
We don’t have to examine cases outside of the AV business, such as construction or research and development costs to understand sunk costs. With some thought we can find examples that we’re all familiar with.

And just like builders, AV pros can find themselves in situations where an AV installation, particularly if it’s a legacy system can reach an impasse, where the question must be asked, “Do we keep applying expensive Band-Aids to this mess or do we scrap it all and start over?”

We could be here for days itemizing case studies like that.

The big one that comes to mind, and that affects most of us is inventory.

With AV equipment, the minute a new piece of gear ships from the manufacturer and ends up in distributor or dealer warehouses the clock is ticking on its value.

What’s cutting edge and in-demand today, is obsolete and fit only for a trip to the recycling station a few years later.
I still recall a conversation I had with the then-area rep for several brands, including Onkyo/Integra. It was the year that their AVR line debuted HDMI switching with built-in video scaling.

Talking about their performance, he exclaimed, “I can’t tell you how glad I am that I sold off my $20,000 Fujitsu video scaler last year!”

In this business your inventory is always at risk of being a sunk cost.

Once past the best before date, it doesn’t matter what you paid for it, you’re not going to get your money out of it. And any further decision making can’t be predicated on what you’ve already spent for anything you own that’s on its way to becoming an antique.

In order to shed the mindset that leads you deal less-rationally with sunk costs its necessary to disassociate from those prior decisions. Sunk costs weigh most heavily on those who feel personal responsibility for having made those decisions at the time. And while the may well have been the best choice at the time, you need to know when it’s time to let go.