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On Sunk Costs and Love

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MARRIAGE RUT

Invariably, the best professors in any field can take even the most mundane subject matter and make it interesting by applying business concepts to real life scenarios (as I do in my earlier blog post). The most engaging lectures will draw parallels between monotonously technical subject matter and the observations of a thought-provoking, intellectually curious third eye, enabling a deeper conversation with oneself that leads oneself to refer to oneself, as "oneself" (which inevitably leads to run on sentences).

Managerial accounting, seemingly, is not one of those classes. While the name, in and of itself, sounds infinitely boring, it's actually the accounting for normal people (like me). This is less about debits and credits, balance sheets and assets vs. liabilities and owners equity and more about what reason and logical decisions you can make with the information. It's a humanistic approach to accounting. According to someone smart with a great deal of academic credits, "Management accounting is a discipline based in economics and psychology that involves the development and use of non-financial and financial information with the goals of motivating and controlling behavior, informing decisions and measuring performance." I give you that definition to establish some context as to where a particular conversation began and how this blog ends. A professor, whom I regard with great respect and honestly wish we had more time with in my program, innocently took managerial accounting down a winding road where I, was waiting roadside, in a bush, ready to pounce.

In class, the professor introduced the analogy of dating and marriage to deliver a point about "sunk costs." For those of you who are normal people living normal lives, a "sunk cost" is defined as those costs necessary for an activity that cannot be reversed or recovered if the activity ceases. This happens in many companies at many stages, but the most important factor to understand here is that it is a critical juncture for management to consider whether the project at hand has cost too much and recouping costs or making a profit is unlikely so you consider bailing, or the project has so much invested already, the company can't afford not to continue its efforts (and spend more money) to make sure it becomes profitable.

So, the professor proceeds to ask the class, one student in particular (it is important to note that this student was a woman) hypothetically, if she had been dating someone for 10 years and her beloved suddenly decided he wanted to get married and she wasn't sure, would she take into consideration the 10 years invested? Her response was, "Well, it depends upon the shared assets," to which he (laughed and) responded, "Let's forget about the shared assets for a moment, would you think about the 10 years you'd spent, invested in this relationship before you made a decision?" Her answer was, "Of course." He then posed a more direct question to the class, "are there any of you who would not consider it?" About six hands (out of 70) went up quickly and slowly down to half-mast.

Sidenote:

Executive MBA programs tend to draw a low percentage of women, mainly because the program is designed for current managers and senior executives, which results in the mean age of these students being 37. This also results in most students being married, and not surprisingly, the women are often not married. Unlike full-time MBA programs, EMBA students are well into their careers and generally know what they want to do with the rest of their lives. Naturally, this program is typically not selected by many women because it inherently creates a self-selection of those who are around the mean age due to career experience and are so focused on their career advancement that they can and will forgo "starting a family" and instead, invest the next two years (as I like to refer to them, go or no-go baby making years) to getting their MBA while they run divisions and companies. This, by the way, is an "opportunity cost." (Those women who enter into this program and are married with children are super humans and have my greatest respect, admiration and awe. I have no idea how you do it.)

Several of the students in the "would not consider the time" population commented that it was a pragmatic decision, but also posed other alternative scenarios; maybe there's a reason we're not married, maybe the relationship has come to a natural end. I listened carefully and slightly twitchy and at a particular point -- he said he wanted to specifically hear from the single women in the room -- to which this lioness (please note: not cougar) pounced.

My reaction to the entire conversation was such that I was puzzled by the analogy posed -- while realizing it was intended to be simplistic and conceptual, the conversation had stepped into the deeper dookie that plagues many women in their 30s (20s and 40s as well, but really in your 30s). My main problem with this discussion was that we kept implying that the 10 years spent was the same as 10 years invested, which is simply a false and frankly, dangerous analogy to draw, albeit subtle. I had issue with the assumption because spending 10 years falsely implies that the individual only did and should begin investing the time with a specific and definable end return on that investment -- which would be marriage.

In The Reasons of Love, written by best-selling and brilliant author Harry G. Frankfurt, there is a short chapter where love is discussed with respect to relationship parallels between the lover who loves, the importance of his love to his beloved and "the final ends and the means by which they may be reached." If you've ever read Frankfurt's work (I highly recommend On Bullshit with a scotch) you will understand why I'll crudely paraphrase, to the best of my ability, what he explains on love and the ends to which we justify the means. Using this context, Frankfurt explains that effectiveness entails "instrumental value" and the total value determines its usefulness. In business parlance, this is "terminal value," which is the value of an investment at the end of a period, which takes into account a specific rate of interest. Frankfurt goes on to say that the terminal value is "in no way dependent upon the value of the means that make its attainment possible." Essentially, the relationship is asymmetric and in the context of the originally posed hypothetical, the NPV of the relationship is nil unless the terminal value (marriage) is reached, which is ridiculous and inherently wrong and led me to draw my own absurd analogy. I can quantify the amount of time I've spent (or invested) on a toilet and determined no terminal value for that investment of time, but I can say without a shadow of doubt, that even in the absence of a terminal value, there was present value (and I believe will hold future value) at the time it was spent. So, the inherent flaw in the hypothetical scenario posed by my unsuspecting professor was that if we are to use the example of relationships as businesses and time as an investment to which we assign equity and the only terminal value of the relationship is defined by marriage, then we must also consider the NPV of the benefits derived of the relationship over the entire period in which we "reasonably" surmise the value must come to fruition.

Furthermore, this inference not only improperly assigns the value of a relationship as only its terminal value (and fails to ignore the recurring benefits during the relationship, but also fails to include the "value of the option," that is, the intrinsic value one receives from the possibility that the relationship will not terminate at all (or at least for a very long time).

Of course, one might also consider the "opportunity costs" -- namely the benefits, option value and terminal value one might receive in a different relationship. Therefore, my Net Relationship Value (NRV) equation is as follows:

NRV = (Sum of the recurring relationship benefits + terminal value of the relationship + option value of the relationship) - opportunity costs

If, at any defining/deciding moment one reflects on a go-no go decision in a relationship one might apply the NRV formula in the decision. The professor's inference is that one should ignore the benefits inured and opportunity costs to-date (sunk costs). The fallacy in the inference is that the net of those costs would be a negative investment. Our point of difference is that I believe they are a positive or at the very least, zero.

In all fairness to the professor, the situation was posed to draw a relative understanding of a managerial accounting concept and to make it fun (though I have probably taken the fun out). These observations are actually not directed at him and his teaching ability; for the record, he is wicked smart, funny as heck and one of the best professors I have ever had. The point of all of this is that the professor is only drawing upon the reality of how society thinks and behaves and how we subconsciously evaluate matters of the heart -- without much head. Truthfully, I don't know anything about anything when it comes to relationships; perhaps if I go sink more costs into the toilet, I will come up with a formula on how to yield a financial return on my time on the can.

Special thanks to my intellectual collaborator, the Accountant Formerly Known as Ron.