What are sunk costs?

Sunk costs refer to costs that have already been incurred and cannot be recovered, regardless of future actions or decisions. This concept is crucial in decision-making, especially in procurement and supply chain management, as it emphasizes the importance of not allowing past costs to influence current or future choices. For instance, if a company has spent a significant amount on a project that is not yielding the expected results, the funds already spent should not factor into the decision of whether to continue or abandon the project.

Understanding sunk costs helps organizations avoid the "sunk cost fallacy," where decision-makers might irrationally continue investing in a failing project simply because they have already invested significant resources. By recognizing sunk costs as non-recoverable, companies can make more rational, forward-looking decisions based on potential future value rather than past expenditures. This principle supports more effective financial planning and resource allocation within the procurement function.