When you’ve already ploughed time, money, effort, blood, sweat and tears into a business project that just isn’t working, the tendency is to try and justify your investment by throwing more and more resources at the problem. Before you know it, sacrificing a goat, selling a kidney, or giving away your firstborn child start to seem like viable options. You’re running out of time and resources, and if you change direction now, “this will all have been for nothing.”
This insidious little thought trap is known as the Sunk Cost Fallacy.
Sunk cost fallacy leads people to make wildly irrational decisions. When we refuse to cut our losses or acknowledge the fact that we’ve made a mistake, what would have been a minor loss of resources can turn into a disaster of epic proportions.
Imagine missing your motorway turnoff but stubbornly ignoring the fact. Instead of acknowledging the mistake, you keep mindlessly driving in the same direction until your car eventually plops off the end of a pier somewhere, 300 miles from your target destination.
If you’d faced up to the initial error right away, you’d be looking at a 15-minute detour and a minor increase in fuel costs. Thanks to sunk cost fallacy you’ve exceeded your fuel budget three times over, you need to buy a brand new car, you’re facing considerable embarrassment, and you’re several counties over from where you wanted to be – THIS is the damage it can do.
How are founders susceptible?
Sunk cost fallacy can be a crippling problem for experienced founders, entrepreneurs and business owners; where success and growth are synonymous, there is risk-taking, investment-making, and sunk costs lurking in the shadows.
Sunk cost fallacy is often hardest to avoid where the most innovative ideas are concerned. Take Concorde, for example. Supersonic air travel? It was a fantastic idea on paper! Unfortunately, it’s also one of the biggest and most well-studied examples of sunk cost fallacy at work…
The Concorde programme ultimately cost around 10 times more than anticipated (the equivalent of between £9 and £13 billion today, vs the original £1.39 billion budget). Whatsmore, it became evident to stakeholders mid-build (!!) that the project would never be commercially viable, as airlines would need to charge upwards of £8,000 per return transatlantic flight to cover costs. Yet under the spell of their original idea and haunted by unrecoverable costs, they carried on regardless – and we all know how that turned out.
As a founder myself, I’m no stranger to failed ideas and abandoned projects. I know that some of these projects were not abandoned soon enough, and that my losses were greater as a result. I also know that many other business owners can relate.
Sunk costs are, by definition, irrelevant. We, as founders, know this, and yet we are alarmingly susceptible to falling into the sunk cost trap – why?
- Wanting to be “the right type of leader” – Diplomatic, collaborative leaders may feel they’re being dictator-like if they pull rank and turn the wheel to set the vehicle back on course.
- Personal accountability – Most business owners hold themselves to high standards, this can sometimes make it extremely difficult to acknowledge personal mistakes.
- Accumulating sunk costs – If this is your second or third attempt at making something work (we’ve all been there), it’s easy to get buried under the weight of accumulative wasted resources and make very bad decisions as a result.
- Type-A personalities – Founders are often competitive, driven, and extraordinarily stubborn. We need to be in order to achieve our goals, but we also need to recognise when our “carry on regardless” mentalities are leading us astray.
Recognising when to cut your losses
I’m often asked, “how do I know when to cut my losses?” Unfortunately, there isn’t a one-size-fits-all response to this question. The answer depends on:
- How badly things are not working out
- Why they’re not working out
- The negative consequences of cutting your losses now, vs the potential negative consequences of staying the course (and how likely it is that the latter will occur)
- The potential pay-off if you manage to turn things around
- Perhaps most importantly… what your gut tells you to do (providing you’re leaving sunk costs out of your thought process)
The goal is to remain ever aware of the sunk cost fallacy trap, and to recognise that sometimes, “backtracking” is the only way to reach your target destination. Progress isn’t linear, it’s iterative.
Sunk cost fallacy in a post-pandemic world
In a world where change and unpredictability are the new norm, recognising when you need to alter course is essential.
During the height of the pandemic, countless established companies failed to roll with the punches and have dropped like flies as a result. Likewise, those who capitalised on the change in status quo have flourished. Businesses that provide delivery services, or that solve remote working issues, or that offer the latest in home entertainment – for instance – have gone from strength to strength. The question is: will this upward trajectory continue in the post-pandemic world?
Now, perhaps more than ever, founders in their scaling phase must be primed to recognize when something new doesn’t work, or when a previously successful endeavour is no longer commercially viable. Most importantly, we need to be prepared to leave sunk costs well and truly out of the equation, when faced with difficult decisions.