“In economics and business decision-making, a sunk cost is a cost that has already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken.” ref.
Seth Godin uses this example on his blog to better understand the problem using widgets — a fictitious product.
You’ve paid a $10,000 deposit on a machine that makes widgets at a cost of a dollar each. And you’ve waited a year to get off the waiting list. Just before it’s delivered, a new machine comes on the market, one that’s able to make widgets for just a nickel each. The new machine will pay for itself in just a few weeks… but if you switch to the new machine, you lose every penny of the deposit you put down. What should you do?
In this example the $10,000 would be the sunk cost (a loss of the down payment) if you went with the newer machine.
From a business perspective, sunk cost keeps companies like software providers, day-to-day operations going. Sunk cost may include a data conversion, the desired modules, training, and technical support. The software company may give a quote to ‘get started’ for $2,000.00+ for one church. It’s a large sum of money that an organization will pay to ‘get started’ with the software.
Because of these large upfront cost, it’s an incorrect assumption that the software must be able to do everything we need. When the church realizes the software may not be all it’s cracked up to be, they don’t want to change. The initial investment (sunk cost) is too large for them to throw away. Many times software companies lock the church and their staff into a lengthy contracts (eg 2+ years). This makes the staff work with software that makes every day operations miserable. One of the reasons we kept IconCMO to a 90 day initial contract period is to ensure the organization is happy with the solution. We also kept the ‘getting start’ investment low.
There are situations that you do get what you pay for. In other words the more you pay the better ‘x’ is. I find this when buying ketchup as I will not buy anything other than Heinz ketchup and will spend the extra money for it. 🙂 But yet, there are times when paying more doesn’t give you a greater benefit (eg. how ketchup taste) than a less expensive product. Software falls into this category. When evaluating software it is better to look at value instead of price. It’s interesting that price, not value, is one of the first few questions when an organization explores software.
Some questions you may ask are:
- How much are we getting with the package that will help us each day?
- What task will the software not help in and are we okay with that?
- What cost can the software eliminate or reduce?
- Does the software keep our organization compliant with all regulations?
- Once each feature is verified, how much does each feature cost (explained below)?
Feature Cost — To find the feature cost, you would take the total price and divide it by the verified features you know it will do. What’s a verified feature? You saw the software perform it via a webinar or testing it yourself. It was not promised during a power point presentation. All counted features need to be in the system at the time of the evaluation.
This is a 2-part series on Sunk Cost. Please stay tuned for the final part in the series.