The sunk costs fallacy is a cognitive bias that leads people to make decisions based on the past rather than the future. It occurs when someone thinks that the time and money they have already invested in a decision is worth it, even if it no longer makes sense to continue down the path. Sunk costs are important in business because they can influence decision-making and affect future profits. So, how can you avoid the sunk cost trap?
Why entrepreneurs fail to make the right decision when they are in a “sunk cost”?
A sunk cost is an amount of money that has already been spent on a project that cannot be recouped. For example, if you have already invested $100 in a business idea and it has not yet shown any profits, then that $100 is considered to be a sunk cost.
Many entrepreneurs fail to make the right decision when they are in a sunk cost because they are focused on making the decision work instead of looking at the bigger picture. They get stuck in their past decisions and continue with them even though they are no longer working for them.
This happens because of short-term thinking, which is also known as sunk cost fallacy. This fallacy leads to poor decision-making because people are more likely to stick with an idea that has already been invested in rather than making a new decision based on the new data. It’s a natural human tendency to want to continue with an investment. Even if it’s not profitable, because it’s hard to admit that your time and money have been spent for nothing.
How to get over the sunk cost trap?
One of the most common mistakes that people make is to invest more in a project or an idea than it is worth. It’s called the sunk cost trap. A psychological phenomenon that makes us feel obligated to continue investing in something even when we know it’s not worth it. When you’re stuck with the sunk cost, you can’t make an informed decision about whether or not to keep investing and you start thinking of the past costs as well as future costs. In other words, you’re looking at all the expenses from your perspective and not from the perspective of what’s best for your business.
Sunk costs are costs that have already been spent on something, so there is no way to recover them. They are used in decision-making because they help people think about their options in terms of tradeoffs. Rather than just focusing on the present consequences of their decisions.
The sunk cost trap can be avoided by making sure that the project or goal has a defined end date. And by using an approach called “the what-if game” in order to determine what the best decision would be if you were starting from scratch. What if I never made the initial investment? You need to realize that your past decisions don’t determine your future outcomes. You need to see the future as a blank canvas and not be afraid of change.
How to overcome the sunk cost trap in your entrepreneurial journey?
The sunk cost fallacy leads us to make decisions that are not in our best interest because we believe there is no way back and nothing to gain by giving up. However, entrepreneurs recognize this fallacy and can overcome it by using the following strategies:
- Focus on outcomes rather than input. When making decisions about what direction your business should take, focus on whether the outcome will be worth it. Rather than whether you spent a lot of money or time on something in the past.
- Don’t let sunk costs cloud your judgment. If you ‘ve spent a lot of money on something, ask yourself if that investment adds value to your business. In addition to how you can turn it into an opportunity.
- Use sunk cost analysis to your advantage. If you’ve lost money on something, try to work out how much money you would have made if it was successful. This will allow you to make changes in your business so that in the future, this doesn’t happen again.
- Try to find a way to make it up to yourself. If you’ve spent a lot of money on something, don’t let your emotions get the best of you. Instead, try and find a way to make it up to yourself.
- Focus on what gives you the most value, not what gives you the most profit. If you focus on what gives you the most profit, you may end up making short-sighted decisions that don’t benefit your business in the long run. It will always lead to spending a lot of time and money that might not be worth it.
While the sunk cost trap can be overcome by taking a step back and analyzing the situation with an objective mindset, it is not always easy to do so.
A sunk cost is an expenditure that has already been made, hence cannot be recovered. It is a cost that has already been incurred. And the decision-maker does not want to incur more costs for something that was previously done.
The sunk cost trap can be avoided by thinking ahead and looking at your decisions from a more macro perspective. It’s important to think about what your decisions will mean for not only the present, but also the future.
Bonus tips : 5 ways to avoid the sunk costs when starting a business
While starting a business, you should always keep in mind that you will most likely be making mistakes and losing money. The key is to not put too much money into your business, so you’ll have enough to keep going.
- The first way to avoid sinking money into your business is by not getting a loan from family or friends. You don’t want to put yourself in the position of having to pay them back. Because then you’re just setting yourself up for failure.
- Another way is to focus on the growth of your business. Don’t focus on the fact that you’re losing money in the short term. But rather how you can grow and make more profit in the future.
- The other ways to avoid sinking money into your business are by having a solid plan in place, knowing how to negotiate, and not accepting any unnecessary perks.
- Also beware of opportunities that you may not be considering. You may think your idea is unique and unappealing, but other people may be interested in it. It’s important to keep an open mind when starting a new business.
- Finally stay focused on growing new customers and on the long-term growth of your business.
We can think of startup mistakes as sunk costs because they are going to have to be paid back somehow. The most important part of the startup process is learning from your mistakes and not repeating them in the future.