Sunk Costs
10 April 2008I knew business school would come in handy someday. Let’s talk Finance!
One of my favorite professors spoke often about sunk costs, a concept with which I was familiar, but never really comprehended. As defined by Econterm:
“Sunk costs are unrecoverable past expenditures. These should not normally be taken into account when determining whether to continue a project or abandon it, because they cannot be recovered either way. It is a common instinct to count them, however.”
Consider a business that purchased a 100 million dollar piece of equipment that promised to drastically cut costs and improve efficiency. Now imagine the equipment didn’t work… should the company continue to use the equipment just because of the significant investment? What if the old equipment was actually more efficient? The principle of sunk costs states that the $100 million already spent should not be considered in future business decisions. If the company can sell off the equipment as scrap for 1 million, it should do so and consider it a 1 million dollar gain, not a 99 million dollar loss. The loss occurred when the bad decision to purchase the equipment was made initially.
In my opinion, baseball teams need to begin understanding and applying the concept of sunk costs. A player’s salary, because it is agreed upon upfront in a contract, is a sunk cost and should not be considered when deciding to continue or abandon a project.
Let’s start with the Dodgers’ Juan Pierre. He’s obviously the fourth (or fifth) best outfielder on their roster, but ownership (and Torre) feel the need to use him because of his bloated salary. The money is gone… the Dodgers are only hurting themselves by benching a superior player (like Eithier or Kemp).
So now, let’s talk about Barry Zito, shall we? Instead of talking about the 126 million dollar LOSS the Giants must endure, let’s talk about how best the Giants can utilize this asset. If Zito continues to feature a low 80’s-MPH fastball and poor control, should the Giants trot him out there every fifth game? If the Giants have five pitchers better than Zito, shouldn’t he, at best, move to the ‘pen? If Sabes’ can eat most of Zito’s salary and get a couple mid-level prospects from a team that is willing to take a chance on him… doesn’t he have to do that? That 126 million is gone. Long gone. No point hurting the team further.
on April 26th, 2008 at 5:56 pm
D’Wayne would be proud. . .