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R & D as a sunk cost

11 December, 2015 - 16:14

Sunk costs in the modern era are frequently in the form of research and development costs, not the cost of building a plant or purchasing machinery. The prototypical example is the pharmaceutical industry, where it is becoming progressively more challenging to make new drug breakthroughs – both because the ‘easier’ breakthroughs have already been made, and because it is necessary to meet tighter safety conditions attached to new drugs. Research frequently leads to drugs that are not sufficiently effective to meet their goal. As a consequence, the pharmaceutical sector regularly writes off hundreds of millions of dollars of lost sunk costs – research and development that did not yield sufficient fruit. This is a perfect example of a branch of a large firm essentially ‘closing down’: anticipated revenues are not sufficient to cover total costs.