Overcoming the Sunk Cost Fallacy in Your Business Decisions
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Successful decision-making can help companies remain innovative, encourage effective business practices and support the long-term goals of their organizations. When evaluating the viability of a chosen action, strategy or investment, it's helpful to recognize instances of sunk costs. Learning to identify sunk costs and sunk costs fallacies can help companies mitigate risk and make logical business decisions.
In this article, we explain what sunk costs and sunk cost fallacies are, list signs you may be using a sunk cost fallacy in your decision-making, explain how those decisions can affect organizations and provide steps you can use to overcome sunk cost fallacies in your business.
What is a sunk cost?
Sunk cost is an economic term describing an irretrievable investment. The investment could be monetary, or it might be something more abstract, like an investment of time, energy or emotion. If a business has already incurred a cost and has no hope of recovering it in the future, the cost is 'sunk.'
In business, most companies try to make sound decisions when evaluating their prospective costs. For example, they might determine the benefits of implementing a new management strategy or purchasing an expensive analytics software or launching a marketing campaign. While they hope their predictions are good ones, sometimes even the most promising investments can go awry. When the costs aren't recoverable, businesses have to make the tough decision of abandoning their investment and accepting the loss, or of continuing on their current course, probably losing even more valuable time, money or energy.
Related: Four Examples of Sunk Cost
What is a sunk cost fallacy?
A sunk cost fallacy refers to the unsound logic some people and businesses use when deciding how to approach their sunk costs. Certain sunk costs, like rent or equipment, are necessary expenses. Others represent unsuitable investments that companies might do well to reevaluate. Using a sunk cost fallacy, or choosing not to reevaluate those decisions because the upfront cost was high, can harm businesses and cause further sunk costs.
Here are some examples of reasons someone might use a sunk cost fallacy:
Sunk cost fallacies can occur when someone spends large amounts of time doing something before realizing their efforts won't help them accomplish their goals. Even if it makes more sense to move on from the sunk cost, they're unlikely to abandon their course without a return on their investment.
For example, a student two years into their bachelor's degree might decide they're not interested in the subject they're pursuing, but, because they've already spent two years earning credits toward that subject, they remain in the unfulfilling major. Or, someone who is assembling a piece of furniture might realize halfway through building it they made a mistake and need to start again. Instead, they refuse to undo an hour's worth of work and continue to build the furniture incorrectly.
Another instance where you might see a sunk cost fallacy is after a significant monetary investment. For example, a home buyer might purchase a home thinking they can make improvements to the property and sell it for a profit. After spending $10,000 on remodeling expenses, they learn the area isn't as desirable as they once thought. Rather than acknowledging the sunk costs and getting out of the poor investment, they continue to spend money on the house.
In this example, money wasn't the only investment. Remodeling a home also takes time and energy. Like most instances of sunk cost fallacies, poor investments can affect multiple resources at once.
Related: The Complete Guide To Sunk Cost
A company might decide to use a new accounting software to record their business expenses. After months of training their finance and accounting teams to use the new system, they realize the software doesn't suit their needs and is costing them valuable time and effort. However, rather than stopping the training and changing systems, they continue to use the ineffective software.
What are signs you're using a sunk cost fallacy?
Here are some signs you're falling victim to sunk cost fallacies in your business practices:
Irrational decision making
Following through with something simply because it represents a significant emotional or monetary investment can be a sign you're engaging in irrational decision-making and using a sunk cost fallacy.
Data can be a powerful tool to help keep your decisions balanced and objective. When you make a decision as a company, find measurable metrics you can use to evaluate the success of your choices. For example, measure the efficacy of a new marketing campaign by determining if the campaign produced increased engagement, sales or customers. If your metrics produce undesired outcomes, mitigate the risk by changing strategies quickly. Reinforce your decisions with fact-based reasoning.
Resistance to change
In business, you may hear people defend an outdated or ineffective process because it's the way the business did it in the past. By embracing change, you can keep your operations innovative and flexible. If circumstances change, strategies often need to change too. External factors like market changes, competitor actions or technology advancements can influence your business and make previously fine processes obsolete. Consistently evaluating your processes and finding opportunities for growth can establish you as a leader in your industry and make you less vulnerable to sunk cost fallacies.
Related: What Is Innovative Leadership?
Fear of failure
For some, acknowledging a misstep in business practices equates to admitting failure. Working to create a company culture capable of framing failures as learning opportunities can help you encourage an environment of resilience and acceptance. Strive to promote leaders who celebrate their team's contributions even when they don't produce desired outcomes.
Obviously, the goal is always to implement successful strategies, make sound investments and find the best solutions to potential problems, but, by staying supportive of your teams and rewarding innovation, you can motivate them to change course sooner when they realize the time, effort or money they spent is unrecoverable.
How does the sunk cost fallacy affect businesses?
The sunk cost fallacy can have a profound effect on businesses because it can encourage poor decision-making. Companies might follow through with a choice based on pride or fear rather than escape from a poor investment, costing them valuable time, money and energy.
Here are some ways sunk cost fallacies can affect businesses:
In most industries, it's important to think about the actions of your competitors. Investing additional time and resources into something that isn't serving your business can stall your innovation and reduce your competitiveness in the market. By constantly evaluating the effectiveness of your decisions and remaining ready to change practices quickly, you can stay competitive and agile.
A top concern for most businesses is output and productivity. Increasing output without increasing costs can lead to improved profits, optimized processes and more efficient operations. If something is hindering the performance of your teams, it's important to find alternative strategies for improvement quickly. Remaining in an unproductive mode for too long can harm your business. It's better to reduce losses as soon as possible and devote energy to finding a more acceptable solution that supports your long-term business goals.
Using a sunk cost fallacy to inform decisions can reduce teams' confidence in their leader's ability to lead effectively. Being able to recognize when something isn't working for the company can take introspection and humility, but doing so can align everyone toward the common goal of finding a solution. Leaders who can think rationally and admit mistakes often earn the respect of their teams.
How to avoid the sunk cost fallacy
Here are some tips you can use to help you overcome using sunk cost fallacies in your decision making:
1. Stay objective
Staying objective when making business decisions can help you overcome the personal attachments that might influence your ability to make sound decisions. By definition, sunk costs are irretrievable, and further investments of time and money can't change the losses you've already incurred. By staying objective and using logical decision-making techniques, you can better evaluate the effectiveness of certain decisions and choose the best option for you or your company.
One way to do this is with data. You can start by outlining your goals, like reducing turnaround time or growing your customer base. Develop reliable key performance indicators (KPIs) that allow you to measure the success of your investments and strategies. If you find your initiatives don't produce the results you want them to, be willing to leave an unsatisfactory situation.
2. Change your perspective
Sunk cost fallacies sometimes occur because you're hyper-focused on an activity or decision. When evaluating the viability of remaining invested in something that appears to be hurting you, try taking a broader perspective. Consider long-term goals and abilities in your judgments and choose options that support the healthiest and most desirable outcomes. By widening your view of a circumstance of activity, it's easier to see the relative scale of the investment in the long term and overcome the perceived gravity of the loss.
3. Encourage innovation
With a focus on innovation and a general acceptance of changing strategies to support long-term business goals, you can make it easier to acknowledge poor investments. Flexibility and adaptability can be powerful traits in business. Choosing not to follow sunk costs can keep your business practices agile and improve your ability to find desirable solutions.
4. Gain experience
Sunk costs examples are plentiful in both personal and business contexts. Sometimes, the effects of sunk costs can be profound and the losses incurred are challenging to overcome. Most often, however, following through on decisions that represent lost time, money or energy won't change the outcomes. The earlier you're able to recognize sunk costs and change strategies, the less likely you are to incur further losses.
Experience can make it easier to identify when you're using sunk cost fallacies in your decision-making. The more you practice disengaging from activities that don't support your long-term goals, the easier it can be to overcome future instances of sunk costs that could affect your business's success.
Explore more articles
- 14 Digital Sales and Marketing Platforms To Consider Using
- What Is a Consumer Pricing Strategy? Definition and Types
- 21 Online Forensic Psychology Masters Programs
- FAQ: What Is a Company Merger? (How It Works and How To Prepare)
- 9 Types of Student Assessments (With FAQs)
- What Is Graduate School? Why Apply?
- Value Stream Management: Definition and Best Practices
- FAQ: What Is a Baseline in Project Management? (Plus Benefits)
- How To Insert a PDF Into Word as an Image in 5 Steps
- Q&A: What Is Intrinsic Motivation?
- How To Engage Employees
- Bachelor of Arts in Instructional Design: Courses and Skills