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Sunk Costs Can Sink You
In any business decision process, including an IT related one, sunk costs can sink a business. In short, a sunk cost is an expenditure made in the past that can't be changed now or in the future. Most expenditures are sunk costs unless, for example, you purchase product that is fully refundable if you return it. A sunk cost then by definition is a cost that cannot be recovered.
Why are sunk costs important? Let's try a scenario.
A business invests $100,000 in developing a database system (or the Federal government in the gun registry system). The total cost of the system was projected to be $5,000, but cost overruns pushed the total projected completion cost to $150,000. In preliminary tests, it was determined that the database platform is not robust enough to handle the projected work load and the life expectancy of the completed system will only be 1 or 2 years before it will have to be replaced. You are in charge of the project. Do you push the current system to completion and spend an additional $50,000 or do you start over from scratch and spend another $150,000 on a new system, abandoning everything accomplished to date?
The natural human tendency is to think along the lines of " well we have already invested $100,000, let's keep going, I don't want to lose what we have already invested ". However, the correct decision making process ignores the sunk cost. It is irrelevant in any future decision (except of course in learning from your mistakes). Too often business decisions are made placing too much emphasis on accumulated spending on projects and not focusing on what is needed in the future and what will result in cost savings over the long-term. In our scenario, a complete review of the project is warranted and a decision made on whether to abandon the sunk costs in the interest of long-term needs.
Chartered Accountants with an IT designation specialty can advise the small business owner on IT solutions and resolutions to problems. Contact Keith Anderson CA-IT at (780) 447-5830 if you have further questions, concerns, or the need for advice.
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