How Much of Your Costs Are Sunk?

Well, you finally bit the bullet and signed the long-term lease for that great location for your retail shop. Accountants would consider that fixed monthly lease payment as a “sunk cost”. It doesn’t matter if your selling dresses or snow tires- the monthly lease payment will stay the same. The lease payment will not factor into your decisions going forward- it’s a “sunk cost” you cannot change.
Delta airlines came out of bankruptcy after a 19-month restructuring. How did they do it? “By slashing $3 billion in annual costs and transferring excess capacity from unprofitable domestic routes to promising international destinations”. Specifically “Delta cut 6,000 jobs and wrested more than $880 million a year in (wage and benefit) concessions from pilots, flight attendants and other employees”. Airlines have 3 large costs: Wage and benefits, planes (buying or leasing) and fuel. Consider a plane ready for takeoff: If you were Delta, would you take a late-arriving passenger? WHY NOT?! You’ve already spent the money on wages, fuel and the plane. For this flight, those are sunk costs. Why not grab the extra passenger?
The Lesson: The shorter you time horizon, the more of your costs become fixed- think about that last passenger. A longer time horizon means more costs are variable. Think about an airline considering whether or not to open another gate at an airport.
Your Homework: What are your biggest sunk costs? What is the time horizon on those costs changing or being eliminated?
(Source: “Will Investors Board a Revived Delta?” , Wall Street Journal 5/1/07)