You've invested countless hours, resources, and money into making your small business a success. You've made difficult decisions and taken risks along the way. But what happens when you're faced with a choice that could potentially harm your business, yet you feel obligated to follow through because of the investments you've already made? This is a common dilemma called the sunk cost fallacy.

What is the Sunk Cost Fallacy?

The sunk cost fallacy is the tendency to continue investing in a project or decision based on the investments already made, rather than its potential for future success. The term "sunk cost" refers to costs that have already been incurred and cannot be recovered. In other words, it's money, time, or resources that are already gone, and cannot be reclaimed.

An Example of the Sunk Cost Fallacy in Action

You are the owner of a small restaurant that specializes in serving healthy, organic food. You have invested $50,000 in renovating the interior of your restaurant to create a warm and inviting atmosphere for your customers. In the year following the renovations, you saw some success with your restaurant, but business has slowed down over the past few months. You notice that the demographics of neighbourhood has been changing  and as a result your location is no longer ideal. 

You decide to investigate the possibility of moving your restaurant to a new location. After conducting some research, you find a new spot that has higher foot traffic and better visibility. However, you realize that moving to this new location will require a significant investment of time, resources, and money. You estimate that it will cost around $80,000 to move, including leasing the new space, renovating it to fit your brand, and marketing to attract new customers.

Despite the high cost of moving, you feel that it is the right decision for your business in the long run. However, as you start to consider the logistics of the move, you begin to feel hesitant. You remember the $50,000 you spent on renovating your current restaurant, and you can't bear the thought of abandoning all that investment.

You start to justify why moving is not the best decision. You think about the time and effort that went into renovating your current restaurant and feel like you can't give up on your investment. You start to consider other options, such as investing in more advertising and promotions to attract more customers to your current location.

However, deep down, you know that these options are not likely to bring in the same results as moving to a new location. But you can't seem to shake off the feeling that you've already invested so much in your current location and moving feels like giving up on that investment.

This is the sunk cost fallacy in action. Your emotional attachment to the $50,000 you invested in renovating your current restaurant is clouding your judgement, and preventing you from making the best decision for your business in the long run.

As a result, you are likely to continue pouring money into advertising and promotions, hoping to turn things around at your current location. But in reality, you are just throwing good money after bad, and your business is likely to continue struggling.

When the sunk cost fallacy takes over, small business owners can find themselves making decisions based on emotional attachment, rather than objective analysis. This can lead to missed opportunities, financial losses, and ultimately, the failure of the business.

How to Avoid Making Decisions Based on Sunk Costs

Be Honest with Yourself

Ask yourself if continuing to invest in a project or decision is really the best use of your resources, or if you're just trying to justify past investments.

Reassess Your Goals

Reevaluate your business goals and priorities. If a project or decision no longer aligns with your goals, it may be time to cut your losses and move on.

Take a Step Back

Sometimes, taking a step back and looking at the bigger picture can help you make more objective decisions. Take some time to assess the situation from a neutral standpoint.

Seek Advice

It's always helpful to get a second opinion from someone you trust, making sure that they will give you honest, objective advice. Look to a mentor, business coach, or consultant who can offer an outsider’s perspective.

By recognizing the sunk cost fallacy and being honest with yourself about the best course of action, you can avoid making decisions based on past investments and instead focus on what will benefit your business in the long run.

When faced with a decision that involves sunk costs, it's important to ask yourself some key questions:

• What is the objective for your business?

• Is the decision aligned with your long-term goals and objectives?

• What are the costs and benefits of each available option?

• Are there other alternatives that may be more cost-effective or beneficial in the long run?

By taking a step back and considering these questions objectively, you can avoid making emotional decisions that are based on sunk costs and instead make decisions that will help your small business thrive.

Ultimately, by understanding and avoiding the sunk cost fallacy, you can make smarter decisions for your small business and ensure that your investments and efforts are being directed towards achieving your business goals and objectives.