Contractor: “I hate our new CRM system system.”
Me: “What don’t you like about it?”
Contractor: “It’s too hard to modify for our business. And the mobile app is clunky. Half the time the guys can’t use it and they’re either calling into the office or just missing things. I can’t really blame them though–it is hard to use. It’s costing me business.”
Me: “How much business are you losing?”
Contractor: “It probably costs me one sale a week. And at least several hours of time doing things manually that we shouldn’t have to.”
Me: “What will it take to fix it?”
Contractor: “My developer can tweak things further for another few thousand bucks, but it’s not going to be great. It’s not intuitive, and we’re going to keep putting on bandaids and coming up with workarounds.”
Me: “Why don’t you change it?”
Contractor: “I wish I could. We just invested almost $10,000 in buying it, hiring someone to modify it, and 6 months training people on it. We’re stuck with it for now.”
Having just spent $10,000 in hard costs and at least that much in soft costs on training, this contractor is stuck in the past. By his own estimate, his CRM system is costing him more than a half million dollars annually in missed revenue opportunities and higher costs because of inefficiency. But he won’t let himself do anything about it because he’s already invested $20,000 in something that doesn’t work. Missing $500,000 because of a $20,000 investment?
It’s an easy trap to fall into. Money already spent is a “sunk cost”. We can’t get it back. But we’re averse to loss, and we don’t want to lose our “investment”.
In the example above, the contractor should look at ongoing and future costs, what does it cost with the current system, and what would a better system cost? And what are the opportunities under each path? (Yes, he also needs to consider the likelihood that he’d make a better decision choosing a new CRM system than he did this time!).
Despite having just gone through the CRM change process, I think his best option is to ditch it and get something that works a lot better for his business. We tend to wear sunk costs like an anchor, however, holding us back, rather than cutting loose and moving forward to a better future.
It helps to be aware of this bias so you can resist it where it makes sense to do so. (BTW, your customers have this same bias, too–it helps to understand why they’re resisting change, too!)You just spent $10,000 on a website redesign. You tested it with several non-industry friends, and some of your family (who look like your customers) and they uniformly don’t like it. They liked a comparison site that you showed them—from someone that runs a similar company across the country. Your designer says the changes you want to make will cost you $2,000. It would cost you $2,000 to dump the redesign and go with something very similar to the other company’s from the same vendor they used (you wish you would have picked them first) that will give you even better functionality, a better content management system, and better integration with your customer database. What do you do?
Research suggests that you’ll probably stick with the disaster that you’ve just spent the $10,000 on. And that is likely not the best thing you could do. For the same $2,000, you could get something better by abandoning the bad effort and going with the new vendor. That would likely be the better choice.
There’s a good chance you’ve been a victim of the sunk cost fallacy. Almost all of us are from time to time.
Sunk costs, whether dollars or blood, sweat, and tears, are costs that have been paid already and that you cannot get back. The money or time have already been spent.
And thus you should completely ignore them. Once the resource has been spent, your question should be, “what is the best way forward today?” Yes, often times the best way is to build on your initial investment and keep pushing forward. But other times, it makes sense to completely abandon the effort. With the latter, most of us struggle.
I just reread a paper I wrote in grad school days. It reminded me of the Kahneman and Tversky experiment that first pulled my attention to the area of behavioral economics.1,2
Going further, Arkes and Blumer conducted a few experiments in 1985 which really showed our tendency to make different decisions based on sunk costs. In one they asked subjects to assume they had spent $100 on a ticket for a ski trip in Michigan. Several weeks later they bought more tickets for a trip they though like even better. Only after buying them did they discover the two (non-refundable) trips overlapped. They had to choose which trip they would take.3
54% of the people said they’d go with the more expensive trip, even though they’d enjoy it less. The money is already spent for both. You can’t get it back. Choose the one you think is better!
We hate to lose stuff, and we make bad decisions to avoid losing stuff, even if it means missing out on something better!
Next time you’re evaluating a marketing campaign, a new product line that you’ve invested in, or a training program that you’ve just spent a lot on but that someone else can deliver to your staff better for less, try hard to ask yourself given where I am today—and ignoring what I’ve already spent—what’s the best way forward?
1The paper, The Framing of Decisions and the Psychology of Choice by Kahneman and Tversky is well worth a read in its entirety. The experiment I’m referring to included these questions for different subjects:
First Case: “Imagine that you have decided to see a play where admission is $10 per ticket. As you enter the theater you discover that you have lost a $10 bills. Would you still pay $10 for a ticket for the play?” 88 percent said yes, and 12 percent said no.
Second Case: “Imagine that you have decided to see a play and paid the admission price of $10 per ticket. As you enter the theater you discover that you have lost the ticket. The seat was not marked and the ticket cannot be recovered. Would you pay $10 for another ticket?” 46 percent said yes, and 54 percent said no.
Economically, these are exactly the same decision. Will you pay $10 to enter the theater now? The only difference is what you did before, buy (and lose) a ticket, or lose some cash. Rational people would make the decision purely on whether it was worth shelling out the $10 to see the play. But we’re just not as purely rational as we think.
2Thanks, Mom, for sending that box of treasure from your basement. Is my beer can collection still hiding down there somewhere?
3Of course, the obvious flaw with this experiment is focusing on skiing in Michigan and Wisconsin instead of places with bigger mountains and lots of snow. Or lots of ice if you want to get the technical chops of my Vermont compatriots. Don’t let that stop you from reading their paper, The Psychology of Sunk Cost, though.