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Focus on the sunk cost fallacy

 

I was watching the popular TV series Lego Masters, and something one of the contestants said really got my attention.

Welcome to Focus On, a focus on a specific topic, business or issue for the month.

So what did she say that captured my attention?

“I’m just terrified I have spent this time building something that now won’t be used. I don’t want that to be wasted building time”.

This is the “sunk cost fallacy” - the predicament we find ourselves in when we don’t want to step away from something we’ve spent time or money on, even though that’s the sensible thing to do.

Sure, here we’re talking about Lego, but this same tendency crops up in business all the time, affecting how we make decisions and how our customers behave.

For example, have you ever continued to spend money developing a product that just wasn’t selling? Or spent hours on a project that had no chance of succeeding, rather than switching your focus to something else? Maybe you’ve continued to read a book that you didn’t like or spent more money on a car that kept breaking down?

In business, we often see the sunk cost fallacy crop up in funding decisions—like sticking with a new CRM database or new and expensive website even though it’s not performing.

So why are we susceptible to the sunk cost fallacy? 

A couple of reasons.

Losses are painful, and rather than be confronted with a loss we try to avoid the moment of reckoning by throwing more money or time at the problem.

And seeing something fail hurts our ego. We can get worried about our credibility or reputation.

Right, that’s a bit about the ‘why’ of the sunk cost, so how do we stop it getting in your way, or even turn it to our advantage?

How to prevent the sunk cost fallacy getting in your way

Let’s first talk about how to outwit the sunk cost fallacy.

The rational thing, because we’re talking about money or time you’ve already spent, is to ignore that you’ve done so. It’s in the past. You can’t get the money or time back—you can only make it worse by continuing to sink money or time into it.

But we’re human, and ignoring something we want to see bare fruit is extremely difficult.

Instead, here’s what you should do.

  • Before you invest in a project, establish clear go/no-go criteria. It’s important to do this before you get sucked into the project so you have an objective perspective later on. 
  • When contemplating what to do, pretend you are giving advice to a friend - this psychological distance will improve your objectivity and soften the blow to your ego.
  • When crunching the numbers mid project, develop your financial projections using a zero baseline — in other words, do not include the cost it's required to get to this point.
  • Make it painful for yourself to continue. Note the opportunity cost of continuing to invest time or money into the product or project. What else could you do with the resources it is absorbing?
  • Instil a culture of acceptable failure in your business. The “fail fast” mindset is helpful here – when we know more we can make better decisions, and part of knowing more is knowing when something isn’t working.

Using the sunk cost for advantage

So that’s if we want to reduce the sunk cost fallacy, but there are times when we might want to use it for advantage.

What do I mean?

Let’s say you want your customers to renew with you.

Your message can be drafted in such a way as to give rise to the sunk cost fallacy. Something like “thank you for continuing to support us”, or “you’ve been with us for xx years” brings continuity of the relationship to mind.

Loyalty programs that carry points can also be effective because it’s more difficult to walk away from benefits you’ve accrued.

It’s not only renewals. Sunk cost can help in customer acquisition, too.

In a store, handing the product to a customer or having them try it on increases their sense of ownership, making it harder to walk away.

And with software, getting a customer who is trialling the product to include things like their business name and logo also increases the odds they will stick around.

So that’s our Focus On the Sunk Cost Fallacy. Rather than let this new knowledge go to waste, make sure you take steps to mitigate its effects on your own decision-making, while supporting the decisions of your customers.

 


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