By Jimmy Guterman
Imagine you’ve spent one million dollars developing a terrific iPhone hardware add-on. That’s a lot of money, but it’s really good. You’re almost ready to bring it to market.
But first there are some small issues you and your team have to work through. For one, the device is optimized for the iPhone 5S, and you’ll have to devote an extra $200,000 to adapt it for the iPhone 6 line. That might not be a big deal; it’s a relatively small additional investment compared to what’s gone into the product already, and you’re confident that you can get it to market in only three more months, maybe even 10 weeks if everything breaks right. One other thing you have to consider: a bit of the functionality of your hardware add-on now happens to be built into the iPhone 6. Again, that might not be a major issue, since your implementation is far superior and your device does so much more than that one feature. You and your team have worked so hard. You’re so close to the finish line you can almost see it. Shouldn’t you just see it through?
Well, maybe you shouldn’t.
First stop and consider whether you’re succumbing to what management experts call the sunk cost fallacy. Sunk costs are investments that you can’t get back. That $1 million is gone, no matter what you do. You’ve spent it. It’s possible that the additional $200,000 will make everything right in the world, but it’s not a sure thing. And, regardless of whether it will fix the product and maintain its attractiveness to the market, it’s still more money you have to spend now. The hypothesis upon which you invested that original $1 million may not hold up nearly so well when the costs increase by 20% at the same time that some of what were unique features are becoming available elsewhere (like built into the new iPhone).
In the mid-‘90s, when the web was young, I worked for a well-funded commercial online service that was going to beat AOL, then the primary consumer gateway to the Internet, by offering an experience based not on proprietary clients, but free software like Netscape Navigator and RealPlayer. The move away from a proprietary client was a prescient idea, but Internet software development was moving so quickly back then that we regularly had to rethink what we were building in order to keep up, repeatedly investing “just a little bit more” to justify our initial large investments. We kept making incremental change after incremental change, we never shipped, and the service disappeared before it ever began.
There were many reasons that project didn’t succeed, but a big reason, I think, was the belief that if we just made this little change or that little change, we could justify our significant development costs. What would have happened if we challenged ourselves to rethink the basic concept in light of new realities? Though the word was not yet in the vernacular, we may well have “pivoted” to an entirely new idea, one not so reliant on the fast-shifting landscape upon which our original strategy was built.
The hot molten core of money already spent radiates a gravity that is mighty hard to escape. That’s why it’s so critical to force yourself and your product team to pull yourselves out of the drive to ship at all costs whenever a notable change in scope is required. Sometimes, when circumstances change, the best move is indeed to adjust features, even when that requires incremental time and investment. But sometimes the best move is to move on. Sunk costs aren’t malleable things: when they’re gone, they’re gone. No doubt there’s a price to pay when a large development effort has to be scrapped or sold, but that’s a much better move than continuing to run in the wrong direction even after you have a hunch (let alone hard evidence) that you’ve lost your way.
To learn more about sunk costs and how to effectively navigate the sunk cost trap, check out these Safari resources:
- Chapter 4 of Helga Drummond’s How to Be a Successful Entrepreneur goes into the sunk costs trap in detail and offers good advice on how to base decisions on future payoffs rather than what you’ve spent already.
- In Decide and Conquer: The Ultimate Guide for Improving Your Decision Making, Stephen P. Robbins emphasizes how decisions can change only the future, not the past. It’s another good resource for making sure you’re making smart decisions. He also makes an interesting, counterintuitive argument against consistency in decision-making.
- Finally, in Financial Literacy for Managers Richard A. Lambert mounts his own argument for why sunk costs are irrelevant (or should be).