The sunk cost fallacy isn’t something we usually think about when we think about entrepreneurs. Instead, we usually think about it from a consumer’s perspective.
For example, you buy a house that’s maybe a little older than you’d prefer, but you really love that house. The inspection comes back with all kinds of issues, but you figure, hey, we’ll work that out as we go.
So you start working it out as you go, and the issues compound and compound, and new issues crop up, and before you know it, you’ve spent more on the house than the down payment…
But instead of admitting that it’s not working out, you just keep putting money into the house. You fix issues, and then the fixes require fixes, and on and on, but you keep plugging away, figuring that, at this point, you’ve put so much time and effort into this that you can’t walk away…
Except you can. At any point, you can “admit defeat” and walk away, sell the house, and move on with your life.
The problem, for many people, is that the “sunk cost” makes them feel trapped. The “sunk cost” is the money they’ve already put into the house, but especially the money that they put in for all the repairs.
As the investment gets bigger and bigger, people feel more and more trapped.
And that’s just a house. Now imagine that you’ve done this for an employee, for specialized equipment, for your entire business.
Very quickly, the size of the cost that you’ve sunk into these things becomes enormous, so much so that, even when it’s better to walk away, something in you screams that you can’t.
Why The Sunk Cost Fallacy Happens in the First Place
The reason the sunk cost fallacy even exists is that human beings, no matter how rational we may think we are, are creatures of emotion.
It doesn’t matter if you’re a business owner. It doesn’t matter if you’re a titan of industry. You’re a human being, and your emotions are deeply involved in everything you do. That’s a fact that’s been borne out through decades of research.
Most human beings have these three emotional levers buried deep in their psyche that are driving the sunk cost fallacy.
The pain of losing
Admitting defeat hurts far worse than continuing to go forward, especially if you have a mindset of persistence or never giving up.
The pain of wasting resources
If you’ve admitted defeat and walked away, you probably feel like you’ve been wasteful: Of time, of money, of other resources.
That feeling can be extremely painful, so much so that you’ll go on wasting more and more resources just to avoid admitting that you just need to stop and walk away.
The pain of losing your reputation
Humans care deeply about what other human beings think about them. If you “give up,” you may feel that people will think less of you, or perhaps worse (in some people’s minds), they’ll feel sorry for you.
Pride and ego can’t stand these feelings and will drive people to do anything possible to keep them from happening (including continuing to invest in a failed venture).
That’s what we call “throwing good money after bad.” You’ve already got a loss on the books. Don’t keep throwing money at it that could potentially be used for something that’s actually successful.
Examples of Sunk Cost Traps
There are a few very common examples of sunk cost traps that entrepreneurs fall into.
The first and most obvious example is continuing to invest in an idea that’s obviously not panning out.
For example, Blockbuster had a chance to acquire Netflix. Instead, they figured they should keep investing in their old way of doing things (the video store). We all know how that turned out.
Another example is investing in an employee who isn’t working out.
Now I’m not talking about someone who’s been working for you for 30 days. I’m talking about someone who has been there for a few years, whose performance has been slowly degrading (doesn’t matter why), who just isn’t delivering what they used to deliver, someone you’ve tried to help, you’ve tried to turn around, but who just isn’t improving (again, doesn’t matter why).
Keeping someone like that around is much more common than you would think. Owners get invested in their people, and they often can’t take a step back and see that all it takes to sink a business, especially in the early days, is the wrong person in a role.
Yet another example is refusing to let go of something you’ve worked really hard on, like a feature of your software that you really love, even though customers aren’t in love with it.
The feature might be great, it might be something that you feel should be more popular, but if the reality is that this feature isn’t welcomed by your customers, it should probably go, right?
But how many software companies keep features like this for far longer than they should? This is the sunk cost fallacy in action: They’ve invested so much time and money into the feature that they just can’t let it go.
All of these things can harm your business. Some of them can end your business entirely.
Thankfully, there’s something you can do about it.
Get Outside Perspectives
The biggest thing you can do to fight just about any bias is to get trusted outside perspectives.
This usually means you need to ask for insight from people who, at the very least, understand your business AND have no skin in the game.
This is the main reason business owners come to us: They want an outside, detached perspective on their finances from someone who can give them honest information about what they’re doing right, what they’re doing wrong, and how they can improve.
If you’re looking for an outside perspective, let’s talk.
Financial Planning for High Earners: Your 360º Future™ Is Now. Let’s Get to Work!
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It’s called Your 360º Future™, a blueprint that looks at these major areas of your financial future:
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