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The sunk cost fallacy

“The phenomenon whereby a person is reluctant to abandon a strategy or course of action because they have invested heavily in it, even when it is clear that abandonment would be more beneficial.”

The sunk-cost fallacy creeps into a lot of major financial decisions. Have you ever felt attached to an investment long after you should have sold it? You know you are never going to get your money back, and you know the cost of opportunity is high…but you don’t sell.

Have you ever persevered with a relationship – friend or love – even when the damage to your personal energy is evident? Have you ever taken too long to dismiss an employee because you have invested time and money in their training?

These are all examples of the “sunk cost effect,” which occurs when you choose to do or continue something only because you have invested (unrecoverable) resources in it in the past. Sometimes it is the feeling of guilt, the shame of acknowledging a mistake or the fear of the consequences. It is a normal human cognitive bias.

But it is a core lesson in business economics classes, and also in personal finance self-help books that any unrecoverable cost sunk in the past is irrelevant when deciding what to do next.

In our world at Dircom Partners, we see this happen too often. We speak with companies and individuals who stick with their agencies and even go on to increase their business with them due to the sunk cost fallacy: they have invested in them for too long and they are afraid of losing that goodwill.

Not only are they missing the opportunity to meet other experts who could bring more fresh and modern ideas, but they are also paying a premium price because their learning curve is flat.

We are not advocating here for a full swing. No, don’t risk the continuity of your business, but do healthy “sanity checks” regularly, bringing new agencies on board, to hear new ideas and refresh the enthusiasm and dedication of the present incumbent.

Remember: when sunk costs affect strategic decisions, there will be serious consequences.



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