Decision cost words: sunk, opportunity, marginal and committed costs

Most arguments about cost in a decision are really arguments about which cost is meant. One person calls a figure sunk, another calls it committed, and both can be right until the decision itself is named. The words are not synonyms, and the numbers do not mean the same thing under each.

A decision is a commitment made with the information available at the time. Cost words decide which numbers belong in that commitment and which ones only feel as if they do. Settling the vocabulary comes before any arithmetic.

What to take away

Is the cost sunk or recoverable?

Ask first whether the money can come back. A sunk cost is money or effort already spent that cannot be recovered whatever you do next. Because it is unrecoverable, it is irrelevant to the choice in front of you.

The confusion is with a recoverable cost. If you can sell the asset, get a refund, or redeploy the work, the cost is not sunk, and it does belong in the comparison. The test is not how much was spent but whether any of it can still be used.

Run the question on every line of a proposal before comparing totals. Each line lands in one of two piles: money that is gone, which should not steer the next step, and money that can still be moved, which should.

What you gave up: opportunity and out-of-pocket cost

Opportunity cost is the value of the best alternative you gave up. It never appears in the accounts, because no money changed hands over it. University extension guidance warns that leaving out opportunity costs can produce a decision that raises cash flow but is not as profitable as some alternative.

Its opposite number is the out-of-pocket cost, which does appear. A decision that looks free in the accounts can be expensive in opportunity cost, and that is the whole reason the term exists.

This is why the list of options matters. An option is a course of action you are genuinely willing to take. Listing alternatives you would never choose does not widen the comparison, it decorates it.

One more order: marginal against average

Marginal cost is the cost of one more unit. Average cost is total cost divided by units. They differ whenever any cost does not scale with volume, and the gap between them is where pricing arguments live.

Deciding whether to take one more order on average cost will mislead you in both directions, depending on where you are on the curve. The question about one more order is a marginal question, so answer it with the marginal figure.

Quote each figure together with its name, or the number will be heard as a different one.

Fixed, variable, committed and discretionary

Four more words describe how a cost behaves over time and volume. They are routinely mixed up, mostly because two of them sound like opposites when they are measuring different things.

The Small Business Administration makes the first point in its own terms: costs are fixed for a set level of production or consumption and become variable once that level is exceeded.

Fixed and committed are different properties. Fixed is about whether the cost varies with volume, while committed is about whether you can stop paying it.

For a decision about the next few months, committed is the property that matters, because it tells you what is actually still on the table.

Where risk changes the cost number

A cost figure for the future is an estimate, and estimates come in two kinds. Risk, used carefully, means the possible outcomes are known and their likelihoods can be estimated. Uncertainty means likelihoods cannot be estimated, and sometimes not all outcomes are known.

The practical difference: risk can be priced and hedged. Uncertainty is managed by keeping options open. Calling both risk makes people demand probabilities that do not exist, then treat an invented number as evidence.

Variance is the spread of outcomes. Some decisions have a good average and a spread you cannot survive, which is why the average alone does not settle anything.

Expected value is the average outcome, weighting each possible result by its likelihood. It answers what happens on average over many repetitions, which makes it a poor guide for a decision you will make exactly once and cannot afford to lose.

Base rate is how often something is true across the relevant population, before you look at the specific case. Reasoning entirely from the vivid details of the case in front of you is a standard error, the base rate fallacy, and one of the easiest to check for.

Checks before you quote a cost

Run these before a cost figure goes into any comparison:

The reversibility test also sets how much of this deserves deliberation, and the decision skills guide covers that through five roles. A reversible decision can be undone at a cost you are willing to pay, so it needs less checking than one that cannot.

Where cost reasoning breaks

If you write down only one thing, write down the reasoning and what would change it. The conclusion is the least useful part of the record, and the decision skills fields show the rest of what a record holds.

Common questions

Which of these words causes the most trouble?

Cost, because it has at least three legitimate senses and people move between them mid-sentence. Ask which one is meant before arguing about the number.

Is a fixed cost the same as a sunk cost?

No. They answer different questions. Fixed asks whether the cost changes with volume, while sunk asks whether it can be recovered. Put both questions to every cost before it goes into a comparison.

What if the cost of an option cannot be estimated?

Say so and record the range you would accept. Marking an unknown as unknown is a finding. Substituting a plausible figure so the comparison looks complete is the error to avoid, because what you gave up is the comparison, and inventing it defeats the purpose.