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It’s OK to Let Go: Sunk Costs

I’m sure you’ve heard at some point in time someone say “but we’ve invested all this money so we have to keep going”.  For the folks that say this, the need to continue on a path is directly correlated to how much money has already been spent.  For them I have two words — sunk costs.

It is essential for everyone in business to understand the concept of sunk costs.  Sunk costs are costs that have already been incurred and cannot be recovered regards of what happens in the future.  In other words, what’s spent is spent.  Now I’m well aware of the fact that sometimes this spend is quite large and someone may have expended a lot of time and energy on a project.  But if continuing to put more money in a project is not going to result in positive returns, by all means stop!  What’s spent is spent and spending more is not the road to redemption.

I remember when I worked for a food manufacturer; they decided to start manufacturing a new candy.  A formula was created and a few test runs were made which seemed to go well.  The concept was presented to the sales group to see if there would be an interest in the market for it.  There was instant enthusiasm and work on a marketing campaign was started.  Then they started full-scale manufacturing.  What happened next was anything but good.  The equipment they were utilizing was really not up to the task of a different formulation causing the scrap rates to be 50%+ and getting a good quality product was very difficult.  They tweaked and played but the reality was they needed to buy new equipment to make this candy.  And new equipment wasn’t an option because the return wasn’t large enough to warrant its purchase.  So guess what they did?  Because so much money had already been spent on R&D and the marketing campaign, they plowed forward.  Eventually, they realized it wasn’t going to work and scrapped the project.  But if they had considered what they had already spent as being a sunk cost and stopped earlier, they wouldn’t have had good money chasing bad.

Most businesses are guilty of doing exactly this at some point in time.  A project that creates a sense of enthusiasm and rallies people to it can produce this blindness because everyone wants it to succeed at all costs.  However, businesses need to be disciplined and have ways of preventing the groundswell of enthusiasm from drowning good decision making.  And they need to ensure they have communicated to their employees that if something fails, it’s OK to let go.

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