Business owners need to invest in production tools and equipment to make goods or products, in which the amount of money spent is part of the core capitalization. When sunk costs come into the equation, misconceptions about it develops and can lead to poor decision-making.
In this article, you will gain a deeper understanding of the ways sunk costs can hurt your business and why you should rethink your strategies.
A sunk cost refers to an unrecoverable amount of money spent on a business. For example, the cost of buying new tools or machinery for factory production and the building lease are included in the sunk costs. It’s not taken into consideration when making business decisions or predicting sales, unless your business shuts down and you sell it to make money.
Just imagine putting your time, effort, and money into a sales and marketing project and still not reaping fulfilling rewards. Will you continue to pursue it even if the data says otherwise? How far can you go without hurting your business?
Let's say you have invested a significant amount of money in a category design because you want to make an original product and become the exclusive manufacturer. You have hired consultants and lab technicians and even conducted expensive research to ensure a higher likelihood of success. However, the first year of product launch shows little movement in sales. Will you still continue your project?
Many people think investing too much money in a business project should drive a business owner to the push limits and see how far it can go. However, doing so is a good example of the sunk cost fallacy.
Here's how your business can suffer from this sunk cost fallacy:
Another sunk cost fallacy is overvaluing your business. After all your hard work and years of building up your business, you only want to get your money's worth. For instance, if you are running a family-owned business handed down by your ancestors, reaching the fifth generation of your bloodline, it is understandable that you want to sustain the business. Of course, it's a family legacy you don't want to waste.
Giving so much value to your family business is highly inspiring. However, it can hurt your finances if it has been stagnantly poor for many years. You probably have tried different sales and marketing tactics, and everything seems not to work anymore. Will you still keep the tradition, or change it, or upgrade it?
Remember these tips to avoid the sunk cost fallacy and keep it from hurting your business:
A common sunk cost fallacy is the fear of dragging your business from the starting line again. Business entails cycles of ups and downs, so you shouldn’t be afraid of not reaching the finish line first. Instead, fear should motivate you even more.
Besides, business is not a marathon with a finish line. It's a rapidly changing world, and it doesn’t adhere to rules. One day you are at the top and the next day you may be at the bottom. Keeping yourself misguided by the sunk cost fallacy will just make you surrender instead of trying unique and creative ways to make a success of your business.
There are many misconceptions about sunk costs. You may think you have already invested too much time, money, and effort into a project. Also, it is wrong to think you cannot start from the bottom again.
Overvaluing your business can hurt it if you keep on doing the same things. It is high time to reassess your methods and trust your metrics for better business decisions.