High Performers understand sunk cost

The leading cause of death among humans is human decision making.

Early in my professional career, I had the opportunity to work with Dr. Ralph Keeney, now research professor emeritus at Duke's business school. He's a world-renowned researcher, author, and professor of decision science.

He's easily one of the smartest men I've ever had the privilege of knowing. But more importantly, he's incredibly practical. Decision making, after all, impacts every single thing we do, every day.

One of the most entertaining articles he wrote was one that suggested the leading cause of death in 2000 was decision making. You can read the summary and get the link to the paper here.

While people die for tons of different reasons every year, the underlying dynamics often suggests a better decision (or set of decisions) might have significantly reduced the risk or probability of a person's demise.

Let's face it, most of us make poor decisions.

But I'm not talking just about poor decisions like choosing to drive when intoxicating. I'm talking about the moments when we make no decision at all—because we rely on hope, struggle with fear, or are waiting for more data.

[tweet “A bad decision can simply be someone waiting for more data, because of fear, or relying on hope.”]

In an interview on the Freakonomics blog, Dr. Keeney was interviewed and explained four fundamental decision making mistakes.

  1. Not recognizing, or not properly taking into account, one or more of your relevant objectives that is affected by your choice,
  2. Not identifying, and therefore not considering, an alternative that subsequently came to your mind and was then easily recognized as a much better alternative than the one you had chosen,
  3. Not recognizing, or not properly taking into account, possible future events that might occur, and subsequently did occur, that led to unanticipated undesirable consequences,
  4. Only considering short-term consequences of the alternatives and neglecting any possible long-term consequences.

Do you need an agent?

If you follow the comings and going of famous people—movie stars, athletes, even some public speakers and authors—one of the things you'll find that they have in common is that they all have agents.

The reason for the agent, among other things, is to help them navigate myriad decisions that they'll face in business. Regardless of the debate whether these agents are good or not, or perform to the expectations set for them, what we can agree on is their purpose.

This is often a good call for everyone in situations like that: Bring in a neutral third-party who is there to maximize profit, minimize risk, and minimize the potential of poor decision making.

And the one place where this makes the most sense is when it comes to sunk cost.

What is sunk cost?

Let's look at a simple example.

Assume that you sign up for a gym—with a monthly membership cost. After six months you've spent $180 ($30 times 6) and still not stepped into the gym. That $180 is sunk cost. It's gone. No matter what, you'll not get it back.

But when we talk about sunk cost in business, we're often talking about more than just the actual sunk cost. We're talking about the decisions that get made because we give that sunk cost more value than it's due.

Back to our example, letting the Sunk Cost Fallacy impact your decision making, you might keep spending $30 a month because you've already spent so much that you might as well not quit yet.

[tweet “What you've already spent is spent. It doesn't have to influence your future investments. #sunkcostfallacy”]

Using what you've already invested as a motivator for further investment is the mistake a lot of folks make.

High performers understand sunk cost

In the world of product development, great companies differentiate themselves by knowing how to deal with sunk costs.

It's why stage-gate strategies are particularly critical. You have to be able to walk away from a project when the economics suggest it's no longer worthwhile—regardless of how invested your engineering team is.

In the world of venture funding, they've become experts at understanding and mitigating sunk cost thinking.

It's why most startups that receive A round funding still struggle to get B round funding. Because the initial bet doesn't automatically warrant a second bet.

In the world of recruiting, some of the most effective recruiting companies leverage an understanding of sunk cost motivators with key hires.

It's often easier to hire an executive from one company and place them elsewhere when the employee recognizes that they're done with their existing company and are ready to move on.

In the world of competitive athletics, agents have to leverage and mitigate sunk cost thinking.

It's why they have to help an athlete move to another team in another city, regardless of how much they want to end their career on the same team and location, if they want to maximize revenue in the last stages of their career.

What about the rest of us?

Not all of us have an agent. Not all of us have a neutral third-party explaining why our own thinking is poor or that our decision making isn't optimal.

So what do we do when we struggle with sunk cost fallacies?

The best thing I can suggest? Learn to make better decisions.

And an easy way to do that?

Read Smart Choices, a book by my friend, Dr. Ralph Keeney.