What are sunk costs?

Sunk costs refer to expenses that have already been incurred and cannot be recovered. This concept is critical in decision-making processes, as it highlights that past costs should not impact future business choices. For instance, if a company has spent a significant amount of money on a marketing campaign that is not yielding results, that expenditure is a sunk cost. The focus should instead be on future costs and benefits when making decisions, such as whether to continue investing in the campaign or to redirect resources elsewhere.

Understanding sunk costs helps managers avoid the "sunk cost fallacy," which is the tendency to continue investing in a project due to the resources already spent, rather than making decisions based on potential future value. By recognizing that these costs are irretrievable, businesses can better evaluate options based on forward-looking considerations and overall strategy.