when making business decisions organizations should only consider relevant costs which include the future costs that still needed to be incurred the relevant costs are contrasted with the potential revenue of one choice compared to another to make an informed decision a business only considers the costs and revenue that will change as a result of the decision at hand because sunk costs do not change they should not be considered 
businesses that continue a course of action because of the time or money already committed to an earlier decision risk falling into the sunk cost trap types of sunk costsall sunk costs are fixed costs but not all fixed costs are sunk costs the difference is that sunk costs cannot be recovered if equipment can be resold or returned at the purchase price for example it s not a sunk cost sunk costs don t only apply to businesses as individual consumers can incur sunk costs as well let s say you buy a theater ticket for 50 but at the last minute can t attend the 50 you spent would be a sunk cost but would not factor into whether or not you buy theater tickets in the future in general businesses pay more attention to fixed and sunk costs than people as both types of costs impact profits sunk costs also cover certain expenses that are committed but yet to paid imagine a company that has entered into a contract to buy 1 000 pounds of raw materials for the next six months if the company is contractually obligated to uphold their end of the deal the raw materials are a sunk cost whether the company has paid for them or not because the company will incur the costs regardless of what the company decides to do with the materials the sunk cost fallacythe sunk cost fallacy is the improper mindset a company or individual may have when working through a decision this fallacy is based on the premise that committing to the current plan is justified because resources have already been committed this mistake may result in improper long term strategic planning decisions based on short term committed costs imagine a non financial example of a college student trying to determine their major a student may declare as an accounting major only to realize after two accounting classes that this is not the career path for them the sunk cost fallacy would make the student believe committing to the accounting major is worth it because resources have already been spent on the decision in reality the student should only evaluate the courses remaining and courses required for a different major in business the sunk cost fallacy is prevalent when management refuses to deviate from original plans even when those original plans fail to materialize the sunk cost fallacy incorporates investor emotions that cause irrational decision making the sunk cost fallacy is deeply rooted in biological tendencies as researchers from the university of california san diego analyzed the sunk cost effect in humans as well as pigeons 1there s four common explanations as to why the sunk cost fallacy exists here are the psychological reasons that explain why some decision making processes fail 