Money falling down a hole, concept for sunk cost fallacy

Are You Stuck in the Past? The Costs of “Sunk Costs”

As I sit across the table from a prospective client, we can absolutely agree upon one thing: Her business would be far better off if we built a fresh website from which we could promote her business and grow.

I also know something else: she is not ready to do so.

It isn’t that her business can’t afford a new site. It can. It isn’t that a new site wouldn’t provide a substantial and fairly immediate return on investment (ROI). I have shown her that it will. No, the objections she is raising all relate to her current website, which she had built fairly recently, at some cost and substantial time investment. We are dealing with a classic case of the Sunk Cost Fallacy.

What is the Sunk Cost Fallacy?

The Sunk Cost Fallacy is an economic theory that recognizes the difficulty people have with letting go of sunk costs. In essence, this means that someone will hold onto a bad investment just because they put a lot of time or money into it.

They’ll do this even if a better investment is sitting right in front of their face (much like my prospective client.) The harder (or more expensive) something was, the more we value that item (whether it is logical or not.)

Cited in Thinking Fast and Slow, an example of this is:

Two avid sports fans have tickets for a game that they are excited to attend. One has traveled many miles and paid a lot of money for the ticket. The second is local and received discounted tickets. On the day of the game, there is a blizzard making travel to the stadium treacherous. Which of our two ticket holders is more likely to attend?

Here’s what the ticket holders should do:

Look at the conditions, figure out the costs of getting there from this point, and decide whether the game’s value outweighs those costs accordingly.

But that’s not quite how they’ll proceed. If both attendees love the teams equally (and let’s just stipulate that they do), shouldn’t their decisions about getting to the game from this point be the same? Yes.

But intuitively, we all know the one who traveled further won’t be able to discount the time and effort he’s expended so far to get here. He’ll think things to himself like, “I flew across the country to get here! I can’t stop now!”And he’ll decide to go to the game based partly on the value he’s attached to it by virtue of the costs he’s already spent.

What Does the Sunk Cost Fallacy Have to Do With Small Businesses?

By now, you are likely thinking, “Yikes, Erika! I thought this was about websites! Why are we discussing Econ 301?”

Glad you asked. Sunk costs are important to economic theory because it impacts behavior and can be a business killer.

Suppose you invested in some software and knew that you could reach positive ROI within a quarter and a half. That time passes, and you are still in the red, but you hold onto the software. Another month passes and it is still not pulling its weight.

Instead of seeking a replacement, you find yourself even more motivated to make the poor-fit software work. Worse, when you think about the cost of buying new software, you feel yourself factoring in the money you spent on the software that’s not working, all the training you gave employees, and the extra hours you spent trying to integrate it — even though those costs are done, spent, and don’t actually mean anything in terms of whether it’s cost-effective to buy new software. 

Avoiding The Sunk Cost Fallacy in Business Decisions

How do you avoid the Sunk Cost Fallacy when making decisions? The bad news is that as long as you remain human, you can’t. Good news, you can correct it. The key is to recognize the sunk costs when they occur and then move beyond them.

Some tips on how to do that:

  1. Imagine a world where your first decision doesn’t exist, and you are starting fresh. In that world, what decision would you make?
  2. Unless you’re giving yourself a pep talk about staying in school or finishing the race, “I have put so much effort into this” is irrelevant.
  3. Bring some fresh (unbiased) ears to the decision. They’ll be able to make a decision about the costs and benefits going forward without getting hung up on what you’ve spent so far.
  4. Remind yourself of your original goal. Are you achieving it? What is the outlook for doing so?
  5. If you changed your decision, how easily could you achieve your goal?

Don’t Let Sunk Costs Get In The Way of That New Website

When I left my potential client that day, the questions I left her with were:

  • What are your expectations of your website? Does this current website meet those expectations?
  • Will the website you have now ever be able to provide you the functionality you need to improve your marketing and your pipeline?
  • How much additional revenue would be possible if you had that functionality and were better able to convert more leads?
  • If now isn’t the right time to make the change, when will that be? Why?

Note that all of these decisions are based on the value of her website going forward. Even if the last website was a pricey time-sucking beast, the important thing is whether the website is now and will in the future provide enough value to warrant keeping it around. If it won’t, it’s time to let it go.

Is something getting in the way of investing in a digital marketing agency or creating a fresh, new website to reach your business goals? Then, it’s time to follow the above tips and add one more — contacting Spring Insight for a free consultation.