Don't let "sunk costs" determine your business model

Karl Palachuk

Economists talk about something called “sunk” costs. Sunk costs can be money or other resources. The term sunk costs refers to those resources you have already invested in a business or a project. You can’t get them back. This is different from commitments and plans you’ve made, which can be changed.

Unfortunately, many business owners use sunk costs as a way to avoid making changes – including changes they know they should make. You’ve heard it: “We’ve already sunk so much money into training, tools, and marketing materials. We can’t change now.”

Stop-Doing-What-Doesn't-WorkIn fact, the whole point of looking at sunk costs is to accept the fact that the money’s gone. It’s sunk. It should not be considered in your assessment about the future.

For example, we have invested in some very big software programs for running our company. And the easiest thing to do is to keep moving along the same path, doing what we did before. But what if there’s a better path? What if the long term best solution is different from what you’ve been doing?

Inertia can be a good thing. This is particularly true if everything’s working well and there’s very little change in your environment. But that doesn’t happen very often in the world of technology. More often than not, we live in a world of constant change.

Inertia can kill your business. This is particularly true when it comes to financial decisions. Keeping an employee you should fire is a financial decision. Keeping an employee you can’t afford is a financial decision. Keeping a client you should fire is a financial decision. Keeping a client that’s unprofitable is a financial decision.

ActWhen you make these decisions, please consider the proper use of the concept of sunk costs: The time and money you’ve invested in those employees and clients is sunk. It’s gone. So the real question is how you will spend the next dollar of money or hour of time?

From time to time we do an evaluation of all the products and services we offer to our clients. We consider whether these are the right products and services for the years ahead. Sometimes it’s a very broad discussion such as whether to push tablets vs. laptops. At other times it’s very specific such as one brand of firewall over another brand of firewall.

We have built up some important vendor relationships over the years. We’ve invested time and resources. And to the extent that we’ve built an investment in good will, there’s some real value in these relationships. But when the vendor changes programs, cancels a product line, or moves your primary contact to another department, that investment can vanish very quickly. At that point, your investment is a sunk cost.

It is not disloyal to re-evaluate your vendor relationships from time to time. You might even find that your research unveils products and services from you current vendors that you simply didn’t know about because you didn’t do the research.

Evaluation is a good thing. Self-evaluation, vendor evaluation, tool evaluation, employee evaluation, client evaluation, etc. These are all positive things. Just be sure that you don’t give too much credence to the fact that you’ve already got a lot of sunk costs in these things.

Two powerful questions

My two favorite powerful questions are:

  • What’s changed since I saw you last?

And

  • If you had to remake this decision right now, would you make the same decision?

Some variation of those two questions will give you most of the information you need in most situations. The first will tell you what’s going on with clients, employees, prospects, vendors, and colleagues. The second gives you great insight about whether your current course should be your future course.

That second question is sometimes phrased as “If you had to do it all over again, would you do the same thing?” The answer draws out a lot of the history of how you got where you are. But just remember that history is history – it’s the past.

Look-ForwardYour future is being created all the time. New products and service appear every week. New challenges emerge. The business model you had before the recession needed to be adjusted during the recession. And as the recession winds downs, your business model needs to continue evolving.

So history is important for understanding how you got where you are, but it’s a bad excuse for staying where you are. You swim in a world of change. That’s why it’s worth revisiting your decisions from time to time.

Internal operations deserve the same review process. I know every time I end up “buying” QuickBooks again, I’m tempted to look at less expensive alternatives (including not upgrading at all). We review all of our tools at least once every other year. Just like our client offerings, the tools we use for internal operations and service delivery exist in a changing world.

I remember when we first got a PSA, I remember telling people that it was quite a commitment. I had my house, my car, and my PSA. Then after we hired a few more technicians, it became my house, my PSA, and my car! Luckily, my investment in a PSA never exceeded my investment in the house.

But even with all that money invested, there came a point where we had to make a business decision about whether to keep our PSA or move to an alternative. After months of evaluating the switch, we ultimately moved to a new PSA.

A decision to change does not mean your last decision was wrong

My initial investment decision for a PSA was absolutely the right decision at the time. But four years later, we determined that a different PSA was right for the company going forward. Nothing in our “new” decision changed the fact that our old decision was correct at the time.

Part of the emotional side of relying on a sunk cost argument is that you’ve also invested some emotional capital in the decisions you’ve made. You don’t want to feel wrong. But the truth is that right decisions need to be revisited just as much wrong decisions.

We haven’t fired many people (employees or clients), but most of those we’ve fired were good decisions when we hired them. So getting rid of them had nothing to do with whether it was a mistake to take them on in the first place.

As we look at the evolution of cloud services, mobile device management, touch-screens, and everything-as-a-service, it’s clear that we need to keep evaluating what we sell, how we sell it, and who we sell it to. We need tools, products, and services that fit the emerging business model of our company.

Doing what we did last year will not serve us well. Pushing servers and migrating SBS made us a lot of money for about fifteen years. But that’s the past and not the future.

Now is a great time to evaluate everything in your business and design a new future with new products and new partnerships. Just remember that those sunk costs are part of the past. Keep them in perspective and don’t let them control your decisions about the future.

How do you feel about those "sunk costs" in your business? Do you agree with Karl that they shouldn't determine your business model? Share your thoughts in a comment below!