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When it comes to running a business, sunk costs are everywhere. To help you side-step them, Coupon Chief created an infographic with ways to identify and avoid sunk costs when making business decisions. Whether you’re running a marketing campaign or stocking your supply room, it’s important to recognize sunk costs and avoid the fallacy. 

 

 

Sunk Costs in Business

For small business owners, admitting to mistakes can be hard. However, once your decision goes south, you can either change your strategy or “stick to your guns” and hope it turns around. While changing strategies is usually the logical thing to do, many business owners are tempted to ride out their losses in the hopes that things will eventually get better. 

This temptation is the result of the sunk cost fallacy, a cognitive bias that tricks you into placing value on a previous decision because you’ve already invested in it –- whether that investment is money, time, or energy. 

Let’s look at a hypothetical example. Your company invests $16,000 in a new marketing campaign that’s been active for about four months. So far, the campaign hasn’t met the goals outlined during the project’s proposal and as the campaign continues, it’s only costing the company money. Despite this downward spiral, the marketing manager wants to continue the campaign until its completion at a year because the company has already spent a significant amount of money on the project –– to scrap it now would mean the marketing manager made a poor business decision and render the whole campaign meaningless. 

While $16,000 might sound like a lot of money to walk away from, the fact is that it’s already a sunk cost. The marketing manager can’t get a refund for a marketing campaign, so choosing to continue the project simply because they’ve already invested in it is fruitless. In this example, the marketing manager fell for the sunk cost fallacy. To continue the campaign will only result in further loss, but ending the campaign will cut those losses and prevent the company from hemorrhaging money. 

 

 

The Psychology Behind the Sunk Cost Fallacy

Our need to “stick to the plan” could result from cognitive dissonance, a phenomena which occurs when a decision-maker makes a choice, then experiences negative feelings that are inconsistent with the decision. According to Christopher Olivola, an assistant professor at the prestigious Carnegie Mellon’s School of Business, this is why we most often fall for the sunk cost fallacy. 

In addition to the cognitive dissonance theory, there are other behavioral economic theories linked to the sunk cost fallacy. These include the loss aversion bias and the status quo bias.   Read more about them below: 

  • Loss aversion bias: states that the negative impact of losing something is twice as powerful as the positive impact of gaining an equally valuable thing. 

For example, which would you choose: 

  • A guaranteed payment of $800, OR
  • A 90% chance of winning $900 with a 10% chance of winning nothing. 

If you’re like most people, you’d probably choose the guaranteed $800. 

Now, make this decision: 

  • A guaranteed loss of $800, OR
  • A 90% chance of losing $900 with a 10% chance of losing nothing. 

Are you more willing to take a risk now? Most people are – when a loss is on the line, people are more willing to take chances. 

Check out the infographic here for more on the sunk cost fallacy.

Article contributed by couponchief.com.

 

 

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