As business owners, a primary goal is to make optimal, rational choices on how we invest our valuable time, money, and resources. However, there are situations and times when we may be operating on false or mistaken beliefs that are referred to as The Sunk Cost Fallacy. A sunk cost is a cost that has been expended and cannot be recovered. As the name implies, it is “sunk.”

Sunk costs can be thought of as retrospective, or backward looking. We are continuing down a path because of past decisions rather than making a rational decision that would maximize our outcomes at the present time.

As business owners, we are faced with the sunk cost fallacy on a regular basis.

Consider these two examples:

• Continuing relationships with unprofitable customers – How many times have we kept a customer who we know is not profitable and is clearly not enjoyable to work with? However, we may be telling ourselves that we invested a lot of time and effort to acquire their business and we’ve done business with them for a long time.

• Business costs and investments:  Consider the investment we’ve made in our business already and then we realize that we have outdated equipment, ineffective employees, unused facilities, inadequate software, and or a similar issue. We may be tempted to “hold on to” one or more of these because we have invested a significant amount of money and it would feel like we are throwing our money away.

How can we make a more optimal decision with consideration to the sunk cost?

• Recognize that the investment of time and money it took to gain a customers business or to purchase equipment, facilities, etc is a sunk cost.
• Also recognize that whether a customer is profitable or if an employee was effective at one time, is a sunk cost.
• Consider the energy drain from working with customers or employees that are not ideal or using equipment and facilities that are not up to par, is a sunk cost.

After considering these and other factors important to you, what choice would you make today knowing what we know now? Many times the results of holding onto sunk costs and not making prospective-based decisions can be extremely limiting to future opportunities and can sometimes be fatal to our business survival.

Being aware of the sunk cost fallacy, and how it can distort rational thinking, will lead to better business and personal choices. And better choices will lead to more successful outcomes in business and life.

What actions can we take?

• Be aware when decision-making feels like it is being influenced by past investments in time, money, and resources. If so, question whether the sunk cost fallacy is involved.
• Determine what the decision would be looking prospectively without regard to past, retrospective sunk costs. Evaluate whether this would lead to a more optimal outcome.
• Seek outside input to gain additional insights and perspectives. Often times people who are not tied to the past investments of time, money, and resources can see the situation more clearly