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Being Cheap Isn't Being Smart

By
Education & Training with Sparta Success Systems

Have you ever heard of "Opportunity Cost"? 
It's what you give up in order to get what you choose.  For instance, if you choose to spend your Saturday evening out at the movies, then you can't also spend it doing laundry at home.  If you spend $500 on new clothes, you can't spend that same $200 on groceries.  For each amount of time, money, and energy you spend on one thing, you give up spending it on something else. 

Sunk Costs
There is also a concept in accounting that I love and it's called "Sunk Cost".  This is the one that most business owners miss.  It's the idea that it doesn't matter how much money you've spent on something, you evaluate whether it is a good business decision as of today based on what it will cost from here compared to the return on investment you will see out of it.  What you have spent already isn't relevant to whether it is a good continuing investment today.  That money is gone.  It's not coming back whether you throw more money at the project or not.  It's sunk - just like a ship in the ocean.  You're not getting it back, so let it go rather than spending 15 thousand dollars to try to salvage the $5000 that was in the hold when the ship went down.

Hidden Costs
Then there is the definition of hidden costs.  I can most easily represent this by telling you about my morning.  I went online yesterday to see if I could download The Feminine Advantage onto my Kindle.  Sadly, the publisher isn't offering this book in Kindle format.  So I looked at ordering the book instead.  But I didn't have enough interest in another book or two to get the free shipping, so I'd end up paying an extra $5 to get the book and then I'd have to wait for it.  So I decided to go to a local bookstore.  If I was going to pay full-price, then I wanted instant gratification.  But the bookstore was in the mall and the mall didn't open for 20 minutes after I arrived.  So I went down to find a restroom and found the food court in the process.  Having not had breakfast, I bought some.  This cost me $5.00.  Then, I walked around the mall and saw that Lane Bryant was having a super sale.  I refocused on the goal of th book and went to Borders and waited the 5 minutes remaining to get into the store.  When I got there they didn't have the book in stock and offered to mail it to me - no shipping charges, but at full price.  On Amazon it was $12.12 plus shipping.  On Borders.com it was $17.95 free shipping.  Same price really, except that I had already spent time at the mall.  So since I didn't want the trip to be totally wasted, of course, I went to the sale at Lane Bryant.  Almost $200 later, I left, paid the $5 for parking and made my way home, using up probably another $2 worth of gas in the process.  So, because I didn't want to pay the $5 for shipping a book to me, I ended up spending:

$200.00 - Clothes
   $5.00 - Parking
   $5.00 - Breakfast
   $2.00 - Gas
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$212.00 plus the price of the book and I lost the enitre morning to shopping when I could have been working.

This is the definition of hidden cost - the costs you end up paying as a result of the choices you make that you couldn't have predicted.  Now sure, I have some cute new clothes (really cute actually).  But I didn't plan on shopping. 

Buying the Cheapest Isn't Always Smart
I know someone who is losing her house to foreclosure because she has made a series of bad choices based on what would provide the cheapest short-term solution for a problem and not taking into account the long-term ramifications of the project.  For instance - she installed the cheapest gas heaters she could find.  But when the city inspected a couple of years later, they made her remove them because they weren't up to code for residential usage.  Then she needed to put in new heat - which would be thousands of dollars if she did it right.  So she spent several months researching cheaper options and having multiple contractors come in to give her estimates.  Each one told her that the heating units she wanted to use were not going to keep up with the winter cold, but she was insistent and finally found a contractor willing to put it in.  But by this time it had been four months and we were well into winter.  She hadn't collected rent from the tenant in the property in all that time since there was no heat in the unit.  The day before the contractor was to start putting in the new, cheaper heaters, the pipes froze and burst.  There were 19 breaks in the pipes that had to be repaired and damage to the dry wall ceilings in all three units from the water cascading down that had to be repaired. So she had the pipes repaired and then installed the cheap heaters.  In the meantime, her existing tenant had moved on - having paid no rent for 6 months.  Then the new tenants moved in and discovered that the heat didn't keep up (as the contractor had predicted) and they insisted that their rent be reduced to pay for the extra cost of running space heaters.

So let's look at the numbers. 

The original heating system would have cost her roughly $10,000 to install properly.  Instead she spent (estimated numbers):

$500 for the illegal heaters
$500 to have them installed
$250 to have them removed and cap off the gas lines
$1500 to have the frozen pipes repaired
$600 to repair the ceiling and walls
$2500 to install 4 new circuits and install the new heaters
$4200 in lost rent to the tenant who never paid anything
$800 in lost rent to the tenants whose heat couldn't keep up (this is an ongoing expense)
====
$10,850 total cost plus an ongoing expense of $800/year i rental reductions.  Is this a smart decision?  No. You have to think long-term when you are buying things to make sure that you're making the best decision, not just for today, but ongoing. 

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If you enjoy my posts, you'll love my products at www.SpartaSuccess.com.  Thanks for reading!

Kelle Sparta
Thought Alchemist

Comments (4)

Li Read
Sea to Sky Premier Properties (Salt Spring) - Salt Spring Island, BC
Caring expertise...knowledge for you!

Such a saavy post!    Have bookmarked your thoughtful analysis.    Am pondering the impact of those "sunk costs", too.......

May 20, 2010 06:29 AM
sheryl knowles
Burien, WA

Great post thank you

May 20, 2010 06:48 AM
Mykel Martin
(909) 476-9600 ~ WeLoveSellingRealEstate.com - Rancho Cucamonga, CA
Realty Masters & Associates

I agree - I know people who will drive 15 miles out of the way to save 2 cents on gas! You really have to look at the overall end-cost. I also know people who will spend an extra dollar to get double the amount of food... which ends up spoiling and they have to throw away. Great post Kelle!

May 20, 2010 12:21 PM
Matthew Naumann
Exit Realty Charleston Group - Goose Creek, SC
Goose Creek, SC Real Estate Agent

Kelle,

Great post.  It definitely gets me thinking how I spend my money and time.

Thanks for sharing,

Matt Naumann

May 22, 2010 12:57 AM