In this blog post, we explore how to make better decisions without being tied to costs already paid.

Are sunk costs truly ‘costs’?

When making decisions, we often think about ‘the costs incurred so far’. Phrases like “I’ve invested this much already…” or “We’ve come this far, so let’s just go for it” are something everyone has probably said at least once. But is this kind of reasoning truly the right decision? Today, we’ll discuss sunk costs, a very important concept in economics. Properly understanding this concept makes countless choices, not just in investing but in daily life, much clearer.

What should be the standard for investment decisions?

We often ask ourselves this question.

“Is this a cost-effective investment?”

Are you perhaps judging success or failure by subtracting the initial investment cost from the profit, thinking ‘positive is success, negative is failure’? In other words, are you judging the success of an investment solely by whether ‘you made money or not’?
If so, there’s one crucial point to address.
The ‘cost’ and ‘return’ discussed in investing aren’t merely visible numbers. Without properly interpreting the meaning behind the numbers, you’re highly likely to make incorrect judgments.

The Reality of Sunk Costs: A Hypothetical Case Study

Suppose you’ve decided to open a franchise coffee shop. The following initial investments are required:

Franchise fee: $20,000
Interior design costs: $50,000
Total: $70,000

Once operations begin, monthly revenue reaches $10,000, but operating expenses amount to $6,000, resulting in a net profit of $4,000 per month.
The franchise fee and interior costs each have a useful life of about 2 years. So, over 2 years, the total net profit is $96,000 (4,000 × 24 months). Subtracting the initial investment leaves a net profit of $26,000. Seems like a pretty good figure, right?

Unexpected Variables and New Judgments

However, while preparing to open the cafe, an unexpected event occurred. The area you selected was designated for demolition. Residents are moving out, and customer foot traffic is expected to plummet.
You’ve already paid the franchise fee, and it’s non-refundable. After completing the interior, a new revenue forecast shows monthly sales dropping to $6,000, with net profit falling to $2,500.
What should you do now?
Calculating the total net profit over two years yields $60,000 ($2,500 × 24). Considering the initial investment of $70,000, this results in a $10,000 loss. Most people would ask, “Why pursue a business that’s clearly going to run at a loss?”
However, applying the concept of ‘sunk costs’ changes the story.

‘Money already spent’ is not a cost

The $20,000 franchise fee and $50,000 interior costs have already been paid and are non-refundable. In other words, this money is an unrecoverable cost, a ‘sunk cost’.
In economics, such sunk costs are excluded from future decision-making. Money that is already gone should not influence decisions about the future.
Therefore, the correct questions to ask at this point are these:

“How much additional money can be earned based on future choices?”
“Will choosing this option now reduce the loss, or increase it?”

Closing the store would result in a confirmed loss of $70,000. On the other hand, opening the store, even if profits decrease, allows you to recover $60,000. That means the loss is reduced to $10,000. Therefore, keeping the store open is the better choice.

The Headquarters’ Additional Proposal and Recalculated Options

Here, the headquarters makes a new proposal. Due to the force majeure reason of the demolition zone designation, they offer two options:

1. Open a new store at a different location (no additional franchise fee)
2. Withdraw from opening and receive compensation (full franchise fee refund + $10,000 interior compensation)

Reorganizing the figures:

Opening at a new location: Assuming similar customer traffic, $26,000 profit over 2 years
Choosing to close: Receive a one-time compensation payment of $30,000

At first glance, closing seems more advantageous. However, this calculation has a blind spot.
The ‘franchise fee used to open a new store is money already paid’. In other words, it’s money that doesn’t need to be considered as a new cost.
Therefore, the new choice should be compared like this.

New store opening costs: Interior renovation ($50,000)
Revenue: $76,000 (2-year net profit $26,000 + excluding existing sunk costs)
Net profit: $26,000

Ultimately, opening a new store yields $16,000 more profit than the closure compensation. Which choice would you make?

Don’t get tied down by sunk costs

At the moment of decision, the trap we most commonly fall into is the ‘sunk cost fallacy’.
Money already spent, time already passed, energy already expended…
Let’s consider an example.
You paid $10 to reserve a movie you were looking forward to, but upon arriving at the theater, you realize you booked the wrong film. No refunds. What choice would you make?
Many people think, ‘Well, I’m already here,’ and force themselves to watch a movie they have no interest in. But those two hours are gone forever. You’ve lost time, opportunity, and even satisfaction. That money was already ‘gone money’—a sunk cost.
So what should you do in this situation? The answer is simple.
Forget the money you’ve already lost and make a choice that matters now.

Understanding sunk costs makes life lighter

Sunk costs aren’t just in investing; they lurk everywhere in our lives.
Relationships, marriage, work, business, friendships…
We hesitate, unable to cut ties or end things we should, for one reason or another.

“I’ve invested so much already; it’s too painful to give up now.”

But that emotion, that time, that money—none of it can be reclaimed.
Only by acknowledging sunk costs and making decisions that disregard them can you truly live rationally.
Consider only the new costs and the value you can gain from the choices before you now.
Sunk costs belong to the past; they are not the standard for shaping your future.

Conclusion

Thinking beyond sunk costs transcends mere economic theory; it’s life wisdom for better decisions.
If you’re struggling with a choice, ask yourself:

“Is what hindering my decision now the cost of the past, or the real benefit of the future?”

Now, make a better choice.
The past has passed, and the future is in your hands.
Your wise decisions create greater value.