Luke 14:28-30 For which of you, intending to build a tower, does not sit down first and count the cost, whether he has enough to finish it— lest, after he has laid the foundation, and is not able to finish, all who see it begin to mock him, saying, ‘This man began to build and was not able to finish’?
Sunk-cost is a critical concept for every leader or decision-maker to understand. Making decisions we often have to calculate the cost or effort which will be required going forward, versus simply quitting partways. One of the main determinants of whether to go forward or quit should be whether the project has an all or nothing characteristic. Getting a degree for instance, is usually an all or nothing investment. There is no reward for completing only three years of the program. On the other hand, some programs allow a person to get a 2-year diploma and then either quit or transfer it to a 4-year degree. In this case, it is not a foolish decision to stop at only two years if that amount of learning is all that is necessary for your career. The two years will not have been “wasted” in this case. Basically, when choosing an all or nothing path, the decision whether to quit or continue needs to be made as close to the beginning as possible.
Liberal gas plant scandal
In the Canadian province of Ontario, an interesting and rather sad situation developed several years ago. In 2009, the Ontario government commissioned the construction of two new power-generation facilities, which would run off of natural gas. The local cities were politically quite left-wing and very hostile to the idea of anything other than wind and solar power being built. They protested continuously and threatened to give their votes away to other political parties if the plants were built. In 2011 the provincial election was coming up. It turned out that the cities where the plants were being built also happened to have some potential swing ridings for the closely-contested election.. Despite the foolishness of the action, the Liberal premier canceled the Oakland plant in fall of 2010. Later, in 2011 the Mississauga plant was also cancelled only one week before the election in order to secure votes for the Ontario Liberals.
Think of all of the waste that went into this project. All of the expensive planning, engineering, permitting, consultants, materials, and skilled tradesmen. All of it waste spent in vain. The carcases of the plants remained standing for many years as a monument to human foolishness.
Cash for clunkers
After the 2008 financial crisis, the government was incredibly eager to do anything possible to help stimulate the economy. At the same time the newly-elected Barak Obama wanted to position himself as an environmental good guy by finding policies to promote which could reduce pollution. One idea, “cash for clunkers” was proposed. A person would be able to hand in their ancient vehicle which was getting low millage and receive a government credit of thousands of dollars toward purchasing a new vehicle with greater fuel efficiency. It looked like the program would kill two birds with one stone so to speak; stimulating the economy and cutting down emissions.
What was not considered however, was the sunk-cost of the pollution in manufacturing the new vehicles. Sure, these cars were somewhat more fuel-efficient to drive, but lets consider the full scope. To manufacture a new vehicle, the metal ore must first be mined from deep within the earth. All of the mining equipment releasing pollution and carbon emissions. This ore must then be purified in a blast furnace, requiring temperatures of thousands of degrees. Now the metal must be worked and shaped to make the vehicle’s frame. There is also the transportation to consider between stages. The mines may be located in far off countries and parts sourced from abroad before being assembled into the final vehicle.
Scrapping a gas-guzzling vehicle to buy a more fuel-efficient one may sound like a great idea, but it will actually end up increasing carbon emissions rather than decreasing them. Only half of a vehicle’s lifetime emissions actually come from the exhaust pipe. The other half are released during the vehicle’s creation and manufacture. “Cash for clunkers” was an idea that seemed to be smart and environmentally-friendly, but looking at the wider perspective, actually increased pollution overall. If the program designers would have taken into account the “sunk costs” of the pollution during the mining and manufacturing stages, they could have avoided wasting so many taxpayer dollars on a useless program and instead put the funds to better use elsewhere.
During the late 1950’s Canada was working on the world’s most advanced aircraft, termed the Avro Arrow. Using special titanium parts, the Arrow was designed to go above Mach 2, even without the more powerful Iroquois engines which were planned to be fitted to the craft. If completed, the jet would break all speed records and be the most advanced aircraft of its time. Unfortunately, there were delays and cost overruns in the design and prototype stages. A new Conservative prime minister, Dieffenbacher, had different priorities than the previous Liberal government, and his main priority was to cut costs no matter what. Diefenbaker is often viewed as the “ultimate conservative” in Canada, much as Ronald Reagan was in the United States. The problem is, when we get so caught up on our ideology being the greatest and being unable to find balance, we can fall into the pit of foolishness by carrying it too far. For instance, a conservative is happy to cut taxes and reduce the size of government, and this can have many benefits against financial waste, but when carried to an extreme it becomes a cause of waste as happened with the Avro cancellation. Whatever small benefit was gained by the temporary tax reduction was more than offset by the loss of all of the sunk costs which had been spent on designing and building prototypes for the Avro. Over 400 million dollars (worth much more in 1950) had been spent on the Arrow, and all of this money instantly went to waste when the project was canceled. A “brain drain” occurred in which many of the 14,000 world-renowned scientists and engineers left for the United States to work for NASA, later helping put a man on the moon. There were also another 11,000 people employed in the project’s supply chain. These 25,000 highly-skilled jobs were all lost when the project was canceled.
Cancelling the Avro project, did not recover any of the 400 million “sunk costs.” This money was already spent. Although Diefenbaker would complain about how expensive the project was, he forgot to consider that most of the expense was already in the past and too late to altar. Cancelling the Avro would do nothing to lower the cost that had already been spent on the project. It would only save some future costs for the finishing touches of the design. Rather than cancel the project entirely, a wiser decision would have been to reduce the scope and ambition of what was remaining in it. This would have prevented all of the past expense from having gone to waste.
You should always build somewhat bigger capacity than you expect to need. This allows room to grow into success. The extra cost is very small in comparison to having to demolish and rebuild to get larger capacity.
Surface area is the “sunk cost” volume is the extension-cost. It may seem more expensive to build a bigger building, but it is actually cheaper in terms of capacity gained.
The Bible speaks of a foolish man who built his barns with a limited capacity and did not plan for the possibility of future success and expansion. As a result the only choices he saw possible were to either remain at his limited production capacity, or to tear down his barns (at huge expense) in order to build the larger-sized ones which could handle his increased wealth (of course he did not see the third and correct choice would be to share from his excess wealth by giving to the needy and as a result he was condemned to hell for serving himself as a god instead of fearing God and sharing with the needy).
Let’s say you are on your second year of university taking a computer science program and deciding whether or not to complete the final two years. The tuition is 30k for four semesters combined, plus the opportunity-cost of giving up 16 months worth of wages that you could have been working at a job (lets say that is 60k). So in total, it appear the cost will be 90k to complete the remaining year of schooling. This cost is the tip of the iceberg of course. You also have to consider the value of the “sunk costs” of the previous two years of schooling. You already spent $30,000 on tuition and missed $60,000 in potential wages given up. To quit after the second year of schooling, you will escape the $90,000 cost the third and fourth year will bring, but the earlier $90,000 you spent will have been completely wasted. It’s value will completely evaporate if you quit partways. It will be as if all of the effort and productivity of those two years of your life were deleted or eaten by locusts. Now there are times where it may be wise to quit partways. For instance, if you realize there is absolutely no chance that you will be pursuing a career in the field anymore, then it is best to cut your losses and quit partways. But if you are just feeling discouraged and like giving up, it is better to remember all of the expense and effort you have already sunk into the situation. Is it really worth letting all of that value evaporate for nothing after all of the struggle you put in? Remember, the grass always looks greener on the other side. So for the CS degree, you may suddenly feel it would be horrible to work in a cubicle for the rest of your life and think of the health issues from lack of exercise and how much better it would be to work outdoors. Meanwhile, the person whose job is outdoors is suffering through the hot/cold weather and constant noise and the physical demands of being on his feet all day. This person is wishing he would have chosen a career path where he could work in a cubicle all day and thinking of how wonderful that would be. So quitting partways through your program is probably a horrible idea, unless you are absolutely certain you cannot continue in that path.
The reverse: knowing when to let go
There is a time where a person need to call it quits, even after making a large investment. Sometimes a person only realizes the path was a mistake when already quite a ways down it. Let’s say you purchase a stock and then a few months later news is released that their product has many major flaws and a competitor is emerging with a much better product. As a result the stock price is cut in half. Many will be tempted to think it is “too late” to sell at the lower price and will want to wait for the price to climb back to their breakeven point before selling. This is a mental trap. The situation has changed entirely due to the news and there is no guarantee of the price returning to breakeven; rather a continued decline is more likely. Despite the “sunk cost” of half their investment being wiped out, it is still better to sell the stock in this case, when its prospects have deteriorated and it has no real future. Much better to recover half the investment than to have it go to zero in bankruptcy.
No matter how many sunk costs have been invested, in the end there has to be an excellent future prospects to justify continued expense. Let’s say you spend months trying to train a worker, but it becomes clear he will be a lackluster employee. Sometimes it is better to cut your losses early when it is clear that there are only bleak prospects ahead. Even though the months of expense training the employee will have been “wasted” if you fire him, the truth is this training is already wasted because he is not benefiting from it.
The decision whether to press forward or let go depends on whether the future prospects are still good. If they are still excellent, then there is no point cancelling an all-or-nothing project 3/4 of the way to completion just because it has been expensive. It is better to keep pressing through rather than have all that good effort go to waste. Only quit partways if something major has changed and you are sure the future prospects are very bleak.
The decision also depends on whether the sunk effort and expenses have actually produced any value. Lets say you decided to start a new business and have spent two years operating at a loss, with the business burning through cash. In this case, if the business has not been improving much or coming close to turning a profit, it is better to quit and sell the equipment. The sunk expense was being wasted and burned up and not turning into anything of value. As Ecclesiastes says there is a time for everything. There is a time to press forward, and there is a time to give up and we must use wisdom to discern the right choice for each scenario.