When business people think of sunk costs, if they ever consider the concept at all, think in terms of throwing good money after bad. While that is part of the definition of what constitutes a sunk cost, there is much more to the story. In fact, your own business probably has a few sunk costs and you might not even know it.
Sunk costs are usually related to continuing to pour money into a bottomless pit, with little or no chance of return. Spending pointlessly, and compounding even greater losses, only tells part of the story. Sunk costs are also about the admission of errors. All too often, failure to admit a mistake was made, leads to further spending on a lost cause.
It costs a company dearly, if the decision makers insist on being seen as infallible. Clinging stubbornly to a failed plan, and funding it despite all evidence to the contrary, can be a recipe for business disaster. Instead of projecting the imagine of sound decision makers, the very opposite impression is created. Entrepreneurs and managers, who are unable to identify a lost cause, are usually doomed to failure. The problem is that they take the company, its employees, customers, vendors, and everyone else involved down along with them.
To avoid business disaster, it's important to understand the concept of a sunk cost. In its simplest form, a sunk cost represents money that is already spent, and is unlikely to provide any return. In your own business or personal life, you may have many examples of sunk costs. That gym club membership you bought, and never seemed to have time to use, is a sunk cost. The money is spent, and whether you visit the facility or not, your financial situation remains unchanged.
Instead of accepting the membership money as already gone, however, you will see people try to get some perceived return on the investment. They will spend time and money to feel they got their money's worth from the membership. Either way, the initial expenditure is still in someone else's hands. Note that I am not picking on the health club industry, the example is for illustration purposes only. Any other club membership would suit the analogy equally well.
In business situations, sunk costs appear all the time, with disturbing regularity. Many times, the expenditure was worthwhile and achieved at least some of its goals. Management recognized the money was gone, and moved on to the next project. Not all business owners and managers can let go of money, that yielded no return, so easily. Instead, they compound the problem, and throw the proverbial good money after the bad.
The first step toward preventing sunk costs from mushrooming into super sunk costs, is to understand that the idea was not a good one. In other words, admission of a mistake is required of the decision maker. That is often easier said than done. Very often, a person will stake their entire managerial reputation on a particular campaign.
When things don't turn out as planned, they throw more money at the problem. Instead of remedying the failed situation, the result is just more red ink in the ledgers. It is not a good idea to pin your reputation on a single project. Instead, consider more testing, market research, and pilot programs to manage and reduce risk.
Involve your staff in the decision making process. If everyone agrees the current system is failing, then try something new. Rather than flushing more cash on the failed plan, move to the next page, and spend the money on a different program. If everyone involved in the plan is part of the decision, the collective choice will likely be to scrap the sinking ship. Letting go will save money in both the short and longer terms.
When faced with a sunk cost situation, learn to identify it as an ongoing drain of company resources. If there is no possible remedy, cut the plan adrift, and start over with a new idea.
Your successful and creative company must understand sunk costs, and know when to pull the plug. Admit your mistakes, and move on to a different plan entirely. Your business success depends on it.
