- Recognize sunk costs
There is a piece of machinery sitting in your warehouse. No matter what product your company decides to make, that piece of machinery is worthless. It is old, broken and outdated. But your supervisor comes to you and says “but it cost $50,000.” So what? No matter what decision you come to, that $50k is gone! We call that a sunk cost.
From a personal financial standpoint, here are some examples of sunk cost to help make the concept make more sense:
Sunk costs are those costs that happened and there is not one thing we can do about it. These costs are never relevant in our decision making process because they already happened!
These costs are never a differential cost, meaning, they are always irrelevant. Let’s look at an example:
Hupana Running Company bought a machine for $50,000 that was used to make water bottles. The water bottle line never really took off, so Hupana decided to discontinue the line, and focus their efforts on the running shoes that were the profitable portion of the business. Even though, in hindsight, they should have never added a line of water bottles to their product line, the $50,000 they spent on the machine is a sunk cost.
It would be senseless for Hupana to keep making the water bottles to try to recoup the already spent $50,000, but they could try to sell the machine to another company who already makes water bottles!! No matter what they do with the machine, the 50K is a sunk cost, not to be recovered, and irrelevant to any decisions the company makes now. So we need to just let it go.