How to tackle sunk costs
Discover ways to identify and walk away from these unprofitable financial burdens.
Human nature compels us to try to recoup the value of what we've already invested. But even knowing that an investment is lost can be hard to acknowledge. Unfortunately, this is the very nature of sunk costs. Sunk costs result from spending money on a business initiative that has not paid off. No matter how long we keep at it, we're not going to recover that money. We've "sunk" the money into it.
Common sense suggests we dust off our hands and move on. However, we small business owners and entrepreneurs tend to be optimistic and confident. We keep thinking that if we just stick with it and work harder, we'll salvage the situation. After all, our confidence and perseverance have been major factors in our past success. So we keep spending and allocating resources to it, long after we should have pulled the plug.
One of the biggest challenges is simply recognizing when you're in a sunk costs situation. Once you know you're in one, you can begin to address it. Here are three ways to tell if you're caught up in a sunk costs cycle.
1. The reason you continue to spend money on something is because you've already spent money on it. Step back and take an objective look at the initiative. Ask yourself: Would I go out and do this again, starting from scratch? Does it still make sense? Is it just a bad idea? Has the market opportunity passed by? Avoid spending out of a need to save face or a stubborn desire to succeed.
2. You're passing up good opportunities so you can keep investing in something that isn't paying off. Your business resources have their limits. Everything is a trade-off. Evaluate it from the standpoint of wisely using your business capital. Ask: Is it the best use of my company's money? Or would we get a better return by using our capital somewhere else? Often we spend emotionally, rather than looking at a situation objectively.
3. On some level, you realize you're not going to recoup your costs. Listen to your intuition. If you have a sense of unease about the continued spending, if it doesn't feel right, your gut instinct might be trying to tell you something. It could be a load lifted off your shoulders to consciously confront the situation and make a decision to stop spending on the sunk cost initiative.
A typical example might involve developing a new product that turns out to have huge cost overruns. Each week finds it no closer to being ready for the market. You're faced with a dilemma: Do you keep developing it and trying to make it work, or do you pull the plug and stop throwing away good money?
Concentrate on the future. Don't look at the past. Put the thought of the costs you've already spent out of your mind. Instead, look at future opportunities your company has – which ones you need to take advantage of tactically and strategically. By staying focused on the future, you'll be better able to set aside the mental baggage and guilt over past expenditures, and instead seize new opportunities and better manage future costs.
Also, seek out the counsel of a mentor or trusted advisor who can look at the situation objectively and with fresh eyes. This is when a good CFO or accountant is critical because he or she will run the numbers and not base decisions on emotional reasons.
Remember that the sunk costs dilemma is one that many small business owners face. You're not alone. But it's important to cut losses and move on.