Companion Channel Episodes Strategy

A key barrier to change: SUNK COSTS

In a world that is becoming more and more complex, entrepreneurial decision making is much more difficult than it used to be in the past. In times of constant change, wrong decisions can and do happen. It is the reluctancy to course correct decisions that often leads to high investments into projects that are already dead. In this weeks companion channel, we will shed some light at this phenomenon which is known as the sunk cost fallacy

Each decision maker knows this situation: a former decision turns out to be the wrong choice – it becomes more and more questionable whether the chosen track will lead to the desired results. At a certain point it is pretty clear: the decision – the always difficult weighing up between different valid options – was wrong.

No problem, one could think, since we live in a VUCA world: volatility, uncertainty, complexity and ambiguity have become our constant companions. Hence, entrepreneurial decisions have certainly become more difficult compared to one or two decades ago. So, let´s revise or adapt the decision on the basis of recent learnings. That is the theory.

In practice, we nevertheless can still observe an enormous reluctancy to course correct decisions. This pattern shows up in statements like: “We cannot take the product off the market, because we have recently invested a seven-digit amount in its development. Not talking about the massive and expensive marketing costs!” Or: “We will never withdraw from Bulgaria since we have invested a fortune in establishing our business there!”

What is happening here? We stick to our original decision since we would have to acknowledge that the invested money is lost. We might also fear to lose our face. In addition, in too many companies, decision makers are under heavy short-term pressure to deliver results. As a result, we throw even more money at projects that are already dead.

We call this phenomenon sunk cost fallacy.

The higher the investment amount the more likely it is that we continue. Let´s have a look at a real company example which illustrates that the sunk cost fallacy can indeed lead to disastrous decisions.

We are in the year 2015. The mid-sized FMCG company is proud of its brand recognition, several product awards and a global footprint with eight manufacturing locations. The oldest site in North Germany gets a comprehensive investment program: Facilities are renovated, several lines are improved with new technology and the
manufacturing processes are organized differently. In the following
five years site “North” absorbs a total investment amount of 25 million Euros.

Cut. 2020. The company has continuously lost market share. Too high manufacturing costs, especially in the three German locations, are one of the key reasons. An analysis of the three German sites shows that “North” is significantly more unprofitable than the other two sites. Higher salaries, less flexible working hours and an updated but old machine park are some of the reasons. After long and painful discussions, the management sells the most profitable German site. “We have invested an enormous amount in ‘North’. This should not have been in vain!”

Not possible in your organization? We would be cautious. In a VUCA world, the sunk cost fallacy makes a remarkable career.

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