Navigating the Waters of Sunk Costs: a Guide for Product Managers

Financial decision-making is an integral part of a PM’s role. If it isn’t, you are one of the lucky few.

Still, most of use are often required to make tough choices that can significantly impact a product’s success. One concept that is crucial to these decisions is the idea of a ‘sunk cost.’ Understanding sunk costs can help you make more informed, rational decisions that can ultimately lead to better outcomes for your product. This article will provide a quick explanation of sunk costs, along with three practical examples of sunk costs.

Understanding Sunk Costs

A sunk cost refers to any cost that has already been incurred and cannot be recovered. In other words, it’s money spent that you cannot get back, regardless of any future outcomes. These costs are typically not factored into future business decisions because they will not change, regardless of the situation’s outcome.

Sunk costs can lead to irrational decision-making if not properly understood. This is due to the sunk cost fallacy, a common error in business and personal finance where individuals continue a behavior or endeavor because of previously invested resources, even when it’s clear that the endeavor is not going to result in a favorable outcome. As product managers, understanding and avoiding the sunk cost fallacy can be a game-changer in your decision-making process.

Three Real-Life Examples of Sunk Costs

To better understand the concept of sunk costs, let’s delve into three real-life examples.

1. Research and Development Costs

In the world of product management, one of the most common examples of sunk costs is the money spent on research and development. Suppose you invest a significant amount of money into developing a new product. After the initial development phase, you realize that the product is not as viable as initially thought. The money spent on the research and development phase is a sunk cost. It cannot be recovered, even if you decide to abandon the product.

2. Marketing and Advertising Costs

Another classic example of sunk costs is marketing and advertising expenses. Let’s say you launch a marketing campaign for a new product. Despite your best efforts, the campaign does not increase product sales as expected. The money spent on the campaign is a sunk cost. Even if you decide to pull the plug on the campaign, you cannot recover the money spent.

3. Equipment and Machinery

The purchase of equipment or machinery can also be a sunk cost. For instance, if you buy a machine for a specific production process and later find a more efficient method, the money spent on the machine is a sunk cost. The machine’s cost cannot be recovered, even if it’s no longer needed for production.

Practical Tips for Dealing with Sunk Costs

As product managers, it’s crucial to recognize sunk costs and avoid the sunk cost fallacy. Here are a few practical tips to help you navigate this:

1. Separate Past and Future: When making decisions, focus on the future benefits and costs, not the past. Sunk costs are in the past and should not influence your future decisions.
2. Rational Decision-Making: Make decisions based on what will add the most value moving forward. If a project or product is not likely to succeed, don’t let the sunk costs deter you from making the rational decision to cut your losses.
3. Regular Reviews: Regularly review your projects and investments. This can help you identify any potential sunk costs early on and make informed decisions about whether to continue or cut your losses.

Conclusion

Understanding sunk costs and how to handle them effectively is an essential skill for any product manager. By recognizing these costs and avoiding the sunk cost fallacy, you can make more rational, value-driven decisions for your products. Remember, when it comes to sunk costs, the money is already spent. Your focus should always be on what will bring the most value in the future.