Sunk costs are exactly as the name implies: they are costs that are "sunk". The money spent is irretrievable. It is gone, history, sunk. However, often there is either a misunderstanding or an emotional attachment to money that was spent. This is a difficulty that we, as forward looking project managers, need to remember.
Often times, especially in a changing economic environment such as today, the original justification for a project changes. For example, it may be that investing $1,000,000 in new plant facilities could generate an additional $250,000 in profit annualy. This may have looked like a good project prior to the downturn. However, maybe that anticipated increase in profit is now only $100,000. Where sunk costs come into play is that perhaps we have already spent $600,000 on this additional plant capability. We have $400,000 more to spend. If we don’t spend the $400,00, we will not get the additional hundred thousand dollars in profit that we now anticipate. However, if we look at the full investment of $1,000,000 as giving us a $100,000 profit annually, this would be a relatively poor or at least very marginal investment. The key is to recognize that money already spent is sunk and all that we could really look at is what we can do going forward. In this case, it is to spend $400,000 or an increased annual profit of $100,000.
As project and program managers, we always need to be forward looking. In looking at something like sunk costs, we need to leave them behind and look at future costs as well as future revenues. We need to look at future cash flows. Projects and programs are always forward looking. Looking backward really only applies when it comes to lessons learned. Often times, however, we may have been involved in a decision and may have some regret or emotional attachment to the money or to the decision making process. We need to let that go! We need to be disciplined enough to be forward looking and we need to have the leadership skills to articulate what sunk costs are and to differentiate between sunk costs and costs going forward.
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John Reiling, PMP
Project Management Training Online
Lean Six Sigma Training Online
1 response so far ↓
1 pawelbrodzinski // Jan 19, 2009 at 7:40 am
I’d say that usually looking at cash flow, revenues, profits etc are more for executives than for project and program managers.
In vast majority of cases PM works in specified budget and that makes her constraints. Sure, there are situations where judging financial aspects of a project is delegated to a PM but from my experience it’s very rare.
Looking back have one more justification. To verify whether a project was successful (in terms of money) or not. That sounds pretty obvious, yet I’m still surprised how often people don’t check (or even don’t care). Leaving sunk costs behind can’t be as a reason to reject that analysis.
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