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Note: The Coupon Chief provides today’s blog story and Infographic.Sunk costs are everywhere when it comes to running a business. Though these sneaky traps can cause serious missteps, Coupon Chief created an infographic to help us identify and avoid them when making big business decisions.
Sunk Costs in Business: An Example
Sometimes it’s hard to admit to mistakes. However, once our decisions go south, we have two options: change our strategy or stick to the plan and hope things get better.
Especially for business owners, it might be tempting to ride out a loss in the hopes that things will turn around. But changing our strategy may be the more logical thing to do.
The sunk cost fallacy is a cognitive bias that tries to fool us into placing value on previous decisions because we’ve already invested in them. The kicker here is that we place value on those decisions, even if they no longer serve us positively.
Let’s take a look at a simple example. Suppose you work for a company that wants to try a new marketing campaign. The company invests $18,000 in the campaign, and after four months, the campaign has not hit any of the goals outlined during the project proposal. As the effort continues, your company continues to lose money. Despite this loss, your company’s marketing manager doesn’t want to pivot strategies. He already invested $18,000 and placed his professional reputation on the line by vouching for the project.
In this case, the initial $18,000 spent is a sunk cost. It may sound like a lot of money to walk away from, but unfortunately, that money isn’t coming back no matter what. Choosing to continue the project just because your marketing manager has already invested in it is a logical fallacy and will only result in further loss. However, ending the campaign could help to cut those losses short and help the company avoid additional expenses.
Why Do We Fall For the Sunk Cost Fallacy So Often?
Christopher Olivola, a professor at the prestigious Carnegie Mellon School of Business, says that we get tricked into the sunk cost fallacy because of a phenomenon called cognitive dissonance. It occurs when there is a disconnect between a decision and the emotional reaction we experience afterward.
Other behavioral economic theories could explain why we fall for the sunk cost fallacy. One of these theories is the loss aversion bias. The loss aversion bias hypothesizes that the negative impact of losing something is-+*/+9 twice as strong as the positive impact of gaining something of equal value.
Thankfully, avoiding the sunk cost fallacy is simple as long as you know what it entails. To help you avoid the same, check out this Infographic created by Coupon Chief:
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