Drowned harvest, sunk costs

The soaking wet autumn brings problems. Especially among arable farmers who still have crops on the land and see their harvest drowning and rotting. It raises the annoying question at what point you should decide to give up on such a crop and leave it alone.

Business economists believe that in such a decision it does not matter how much costs and effort you have already spent on the crop this year. These are sunk costs from the past, but how you arrived at the decision point does not matter. Whether you have spent 2.000 euros or 4.000 euros on the crop, whether you have already gotten stuck with your harvester three times or whether you have had to put two tractors in front of a tipper only once: it doesn't matter. At least not if you now have to decide whether to make another attempt or not.

There's no point in crying over spilled milk
The only thing that matters is the value of the harvest that is still in the field, multiplied by the chance that you will get it in the yard, and the costs of harvesting, including damage to the soil. Only future costs and revenues count in a decision - what has been, has been. Or as the English say: there is no point in crying over spilled milk. What's done is done.

Yet the rule of sunk costs is often violated. “So much has already been invested, now we have to move on,” is what you hear in the management meeting. Politics is also strong when there are budget overruns of a mega project again. Yes, if you want to avoid losing face you can ignore the rule, but otherwise it is a fallacy. Completing the mega-project must be weighed against an alternative method of regulating mobility or carrying out the administration of the Environmental Act without software.

A few of those golden rules
Accountants have their own variant: you take losses as soon as they become apparent, profits only when they have been realized. Something similar also applies to the value of stranded assets, machines or stables that suddenly become outdated because manufacturers come up with something better or the government bans the technology. My father once had a beet thinner in the shed, little used and certainly not written off, but suddenly almost worthless because beets could be sown remotely. Then only the scrap iron price counts, no longer the purchase price or the book value.

I learned the rule of sunk costs in the XNUMXs from the book Business Economic Thinking by a certain B. Boomsma. He had a few more of those golden rules. Such as the fact that only future cash flows play a role in a decision, but that this also includes indirect future costs. To stick with the example: you cannot use the extra hours you spend on harvesting to sow wheat on another plot. These hours are therefore not free, the cost is hiring extra labor, and if that is not possible: the loss (the so-called opportunity cost) of not being able to grow wheat.

Three attempts by the tugboat captain
The sunk cost rule is useful in harsh conditions. In the booklets it is usually explained in terms of the tugboat captain who has already made three attempts to tow a ship in heavy weather to a safe harbor and now has to decide on a new attempt. It's sad that the explanation can now also be given with an agricultural example, so above all we hope that it will dry out quickly and that the rule can be forgotten for a while.

Krijn J. Poppe

Krijn Poppe worked for almost 40 years as an economist at LEI and Wageningen UR and now holds a number of advisory and management positions. For Boerenbusiness he dives into his bookcase and discusses current developments on the basis of studies that have become classic.

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