Are You Stuck In the Past? The Costs of Sunk Costs.




  • — October 23, 2017

    As I sit across the table from a prospective client, we can absolutely agree upon one thing: Her business would be far better off if we built a fresh website from which we could promote her business and grow. I also know something else… she is not ready to do so. It isn’t that her business can’t afford a new site. It can. It isn’t that a new site wouldn’t provide substantial and (fairly immediate) ROI. I have shown her that it will. No, the objections she is raising all relate to her current website, which she had built fairly recently, at some cost and substantial time investment. We are dealing with a classic case of the Sunk Cost Fallacy.

    What is the Sunk Cost Fallacy?

    The Sunk Cost Fallacy is an economic theory that recognizes the difficulty people have with letting go of sunk costs – those investments and efforts they have already made in pursuit of some goal and make economically rational decisions for their future. The harder (or more expensive) something was, the more we value that item (whether it is logical or not.) An example of this (cited in Thinking Fast and Slow) is this anecdote:

    Are You Stuck In the Past? The Costs of Sunk Costs.

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    Two avid sports fans have tickets for a game that they are excited to attend. One has traveled many miles and paid a lot of money for the ticket. The second is local and received discounted tickets. On the day of the game, there is a blizzard making travel to the stadium treacherous. Which of our two ticket holders is more likely to attend?

    Here’s what they should do: Look at the conditions, figure out the costs of getting there from this point, and make a decision as to whether the value of the game outweighs those costs accordingly. But that’s now quite how they’ll proceed. If both attendees love the teams equally (and let’s just stipulate that they do, even though they paid different amounts for the tickets), shouldn’t their decisions about getting to the game from this point be the same? Yes. But intuitively, we all know the one who traveled further won’t be able to discount the time and effort he’s expended so far to get here. He’ll think things to himself like, “I flew across the country to get here! I can’t stop now!”And he’ll decide to go to the game based partly on the value he’s attached to it by virtue of the costs he’s already spent.

    How does the Sunk Cost Fallacy Impact Small Businesses?

    By now, you are likely thinking, “Yikes Erika! I thought this was about websites? Why are we discussing Econ 301?” Glad you asked. Sunk costs is important to economic theory because it impacts behavior and can be a business killer. (Stay tuned next month for the ugly details of a marketing campaign gone terribly awry, a case of sunk costs biting Spring Insight in the tush.)

    Suppose you invested in some software and knew that you could reach positive ROI within a quarter and a half. That time passes and you are still in the red, but you hold onto the software. Another month passes and it is still not pulling its weight. Instead of seeking a replacement, you find yourself even more motivated to make the poor-fit software work. Worse, when you think about the cost of buying new software, you feel yourself factoring in the money you spent on the software that’s not working, and all the trainings you gave employees and the extra hours you spent trying to integrate it — even though those costs are done, spent, and don’t actually mean anything in terms of whether it’s cost-effective to buy new software.

    So what do you do?

    How do you avoid the Sunk Cost Fallacy when making decisions? The bad news: as long as you remain human, you really can’t. Good news, you can correct for it. The key is to recognize the sunk costs, and then move beyond them.

    • Imagine a world in which your first decision doesn’t exist at all, and you are starting fresh. In that world, what decision would you make?
    • Unless you’re giving yourself a pep talk about staying in school or finishing the race, “I have put so much effort into this” is irrelevant.
    • Bring some fresh (unbiased) ears to the decision. They’ll be able to make a decision about the costs and benefits going forward, without getting hung up on what you’ve spent so far.
    • Remind yourself of your original goal. Are you achieving it? What is the outlook for doing so?
    • If you changed your decision, how easily could you achieve your goal?

    So about that new website…

    When I left my potential client that day in July, the questions I left her with were:

    • What are your expectations of your website? Does this current website meet those expectations?
    • Will the website you have now ever be able to provide you the functionality you need to improve your marketing and your pipeline?
    • How much additional revenue would be possible if you had that functionality and were better able to convert more leads?
    • If now isn’t the right time to make the change, when will that be? Why?

    Note that all of these decisions are based on the value of her website going forward. Even if the last website was a pricey time-sucking beast, the important thing is whether the website is now and will in the future provide enough value to warrant keeping it around. If it won’t, it’s time to let it go.

    It’s never good news to get stuck in the past. What about you? What decision are you holding on to that you need to just let go of?

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    Author: Erika Dickstein

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