All managers believe they make smart, rational business decisions. When determining the right strategy, they will tell you that they research, weigh their options and execute. But when the decision doesn’t work out, things get complicated. To protect their initial decision, many managers opt to keep investing either time, money or both in the hopes that the situation will turn around. Of course, it doesn’t and before you know it, the investment increases exponentially and the results don’t improve. In other words, the sunken cost fallacy has struck again. In my view, this thinking is detrimental to a team’s sales performance.
Here are two examples of the sunken cost fallacy:
1. Let’s say you buy tickets to a concert. On the day of the event, you catch a cold. Even though you are sick, you decide to go to the concert because otherwise “you would have wasted your money.” Sure, you spent the money already and you can’t get it back. If you aren’t going to have a good time at the concert, you only make your life worse by going.
2. In business, a sunk cost is any past cost that has already been paid and cannot be recovered. For example, a company may have invested $1 million in new software. This money is now gone and cannot be recovered, so it shouldn’t figure into the company’s decision-making process. But is does and sunken cost fallacy has struck again.
Psychologists have described the phenomenon of the sunken cost fallacy as an escalation of commitment where people can make irrational decisions based upon previous rational decisions or to justify actions already taken.
Why is the sunken cost fallacy a bad decision process? Because it morphs into a justification of the original decision and the second decision is not valid on its own. Why does this happen? The reality is that egos can get in the way and managers are more interested in saving their reputations than admitting that they made a mistake with the initial decision. This is evident when managers hire originators who do not make budgeted goals and then fail to address the situation. It can also be seen when companies keep hiring underperforming originators from their competitors instead of hiring rookies and training them.
It makes better sense to cut your losses than support a bad decision.