Business is all about profit and loss, that’s it. Are you sure? Well, it’s definitely a huge part of any business world but behind both of them, there is a backstory too. Not every loss is limited to balance sheets! Losses in a business could arise from wrong decision making. One such loss that could arise is from a sunk cost fallacy! Sounds too fancy? But it’s a full fledged practical theory that is applicable in the real world. I was so intrigued that I wrote a full blog on how sunk cost fallacy applies in business and real life. But did you know that there are many types of these sunk cost fallacies too! Particularly sunk cost fallacy in business goes way beyond common examples. Time to unwrap all these amazing theories.
Best Examples of Sunk Costs in Business
A sunk cost basically means a cost which can not be recovered irrespective of any present or future decision. Still confused? Easiest way to understand any concept: try to understand them from practical examples (my all time favourite way of remembering the most complex of theories!). Now without further ado, here are the majority of examples of sunk costs in business (you will be left surprised by some of them!).
1. Your Precious Time and Effort
Each successful business story has a background of its owner and team’s hard work, blood and sweat. All these once invested can never be returned, that’s why they are essential but also a sunk cost.
2. Depreciation Costs
Each machinery or equipment comes with a depreciation cost. It only gets older and goes through some wear and tear. Even in the balance sheet this cost has an important place. Depreciation of machinery or amortisation is actually a sunk cost.
3. Salary, Rent and Wages!
Yes, you read that right. All these are sunk costs. Why? Because irrespective of whether your business makes a loss or profit, once paid you can’t get them back. (Though they are one of the most important costs to run a business too!)
4. Marketing Campaigns
In today’s digital world, majority of business expenditure is done on marketing campaigns. Facebook ads, Google ads and what not! WIthout a digital presence it’s quite difficult for the business to reach their prospective consumers. But this cost too once invested can’t be recovered. That’s why it’s super essential to keep a watch on the ROI on marketing campaigns. Each cost should be justified by the revenue or results it brings in.
Also, beyond a point investment in marketing campaigns can lead to diminishing returns, you need to keep a watch on that too!
5. Contractual Payments
Payments that are contractual also come under the category of once paid you can’t recover them. This is even if the contract service doesn’t work out and is canceled.
When Do These Examples Turn Into Sunk Cost Fallacy in Business?
Not every sunk cost is bad. For running a business, costs like rent, wages, depreciation etc. are inevitable. But they are all justified because these sunk costs bring with them a return that helps the business in running. There exists a thin line which can turn these sunk costs into a sunk cost fallacy, here are a few examples.
1. Investing Too Much on R&D
Spending money on research and development is a must to build great products and services. But there can be a situation where one can keep spending in hope that there might be a breakthrough even when nothing is working. Also, when you notice the product itself does not have any prospective customers and there’s no demand for the product, then all expenditure on R&D is a sunk cost!
2. Spending on Maintenance of Obsolete Machinery
Imagine you have a machine that requires maintenance of say Rs. 10,000 every month. But the output it gives is zero! Would you consider it as a wise choice?
Why does it happen? Because one thinks only about the past investment done in the machine and keeps spending money in the hope that someday it might help (even though there is no scope because the machine is already obsolete).
3. Not Being Receptive to New Technology
Nowadays each day you wake up, you come across the newest revolution in technology or latest AI innovation! But not everyone is tech savvy. This could sometimes lead to a sunk cost in terms of time, effort and money. One may still stick to old software only because they are comfortable, even when the new tech solution is more efficient and better. The refusal to accept the change can lead to a sunk cost.
4. Ignoring Data and Analytics
Numbers and data are the biggest asset in today’s world. But sometimes the refusal to accept what the numbers and figures are showing about a business’s condition can lead to a sunk cost fallacy. Like you notice that your business is consistently not meeting sales targets and still you continue spending on it. Even after knowing business is going continuously into a loss and has no scope of revival, still continuing with it is the biggest example of a sunk cost fallacy in business.
5. Behavior of Impulse Buying
Low price, let’s buy it! We all are wired to take benefits of discounts, especially massive discounts (who doesn’t love a 80-90% discount?). This attitude can lead to a major loss in business! Sometimes you may buy irrelevant equipment or machinery only because it’s cheap. Like you instantly buy a nail art machine because it was available for a fraction of a price. That too when your primary business is in the food industry with no future plans to go into the beauty industry. This can become a sunk cost.
Any investment in a business should always get you prospective returns.
6. Ignoring Consumer’s Response
Consumer is the king! Knowing consumers don’t like or connect with the product or service and still investing on it without doing changes leads to a sunk cost fallacy. One example is heavily investing on ads for a product that’s consistently given low ratings by the consumers.
How Do Businesses Get Trapped in a Sunk Cost Fallacy?
There can be many reasons why sunk cost fallacy happens. If you love to go into details like me, you can read all about why one gets stuck in the sunk cost fallacy in my dedicated blog on sunk cost fallacy. But with regards to business too, there are a few dedicated reasons.
Emotional Investment
Work doesn’t feel like work if you love it! You must have heard about this countless number of times. But there’s a downside too! In business if you become too emotionally invested, you may start overlooking the open facts that are glaring at you. These facts might be clearly telling you that it’s time to wind up the business and move on. But your emotional side won’t help you make a rational decision.
Ego Comes in the Way
Many times one doesn’t want to accept the business they built so carefully isn’t working. This can become too blinding which in turn doesnt let you make the correct decisions.
Apart from these there are many other reasons with regards to overall business or one particular business decision which I covered with examples in the above section, hope you loved reading each one of them!
Business Consequences of Falling in a Sunk Cost Fallacy
Every business decision has a result! Each correct one helps your business in growing but each wrong decision can impact not only your current business but also your future prospects (Ouch! We don’t want that, do we?).
Here are a few business consequences of getting stuck in a sunk cost fallacy.
1. Missed Opportunities = Future Loss
Resources are limited! Right from your time, efforts to even money, you can spend them in a limit. If you are not able to come out of a sunk cost fallacy, then you may miss potential future opportunities that can help you and your business grow and get profitable.
2. Bad Figures and Low ROI
It’s difficult (sometimes impossible) to get good returns on a bad investment and make a business successful if you don’t take timely and rational decisions.
3. Reputation of Business on the Line
A business grows and prosper on its carefully built reputation and legacy. One wrong business decision can lead to a customer or even investors’ mistrust.
How to Avoid Sunk Cost Fallacy in Business?
Difficult but not impossible. This is the exact answer to this question. While reading about some practical interesting case studies, majority successful entrepreneurs suggested: trust yourself and always take the most rational decisions!
Here are some ways to avoid falling in the sunk cost trap.
1. Focus on Future
However tempting it might be, you need to let go of the past. You might have already invested heavily in terms of emotions or money in a business section in the past. But if it’s clear it will never work, you need to let go and focus on the future.
2. Overcoming the Fear of Regret
Humans make mistakes. Don’t be too hard on yourself. If you know you are getting stuck in a sunk concorde, try to overcome the fear of regret and move on.
3. Avoid Too Much Loss
If one gets a loss in business, general sentiment is to try and cover it up in the forthcoming months. But if the data clearly shows that there is no way this business will work, then don’t do more losses in a bid for loss aversion.
4. Focus on Potential Benefits
The amount already invested will never come back but you need to try and find the light at the end of the tunnel. You could possibly make a new business or do some tweaks with initial investment so that all doesn’t go to waste.
You are your biggest cheerleader and the best decision maker too! Identify sunk costs, to make rational decisions. In turn they improve profitability because limited resources are allocated in the best way. Right from your business decision to pricing strategy to all other things, every step is important to build a successful business. Back yourself and see your business grow.
What’s your favourite business strategy that leaves you in awe?