• Yvonne Root

It Costs to Live with the Lost Cost Fallacy

Updated: Jun 23

Cost is something we can all understand – or not

There is this interesting mindset we humans get caught up in known as the Lost Cost Fallacy, otherwise known as Honoring a Sunk Cost. David McRaney at You Are Not So Smart goes into detail concerning what is entailed in Lost Cost Fallacy.

What it boils down to is, it’s hard to abandon a person, a product, or a process once you’ve invested time or money into any of them. It is hard to give-up when you’ve spent so much. You don’t want to think that you wasted all that time or effort. Weird thing is, it’s hard to abandon some things even when the investment is minor.

Cost is cost, yet it can be funny

Here’s an example. A while back I went to breakfast with some family members. After eating most of my food, I decided it was time to call it quits. There were mostly just bits and pieces scattered on my almost empty plate. Yet, one of the breakfast party was horrified that I was leaving two intact pieces of bacon. She explained that the meat was the most expensive part of the meal and I was therefore under obligation to eat it.

Even when I explained to her that the cost of my meal didn’t vary depending on what or how much of it I ate (or didn’t eat,) she was insistent that I was making a huge mistake. No thanks, she didn’t want my bacon, she had eaten her fill from her own plate on which she “wisely” left only the toast. 😵

Lost cost fallacy in the construction industry

There are three major categories in construction which present temptation for holding tight to the Lost Cost. They are people, products, and processes.

People

Let’s say you have an out of town division led by a hand you’ve had around for quite a while. Suppose you think there is a possibility he isn’t pulling his rightful share of work. There even seem to be things happening which are not a part of the company culture you’ve worked hard to build and reinforce. Perhaps he tells you there are clients onboard because he brought them on. It could be you let yourself worry over the loss of clients as well as workers if you terminate this fellow.

Besides all that, you’ve spent a great deal of time and money getting this guy into the position he presently holds. Could you be honoring a sunk cost?

Overcome this lost cost fallacy. Think, “Am I sacrificing the opportunity to hire someone better because I am stuck with the sunk cost?”  Are you giving up the possibility of better relationships by sticking with something that is leading nowhere? What is the actual cost of your commitment to a past decision?

Product

You had a great project in the pipeline and at the last minute it fell through. In the meantime, you had ordered product for that “great project” and it doesn’t work on any of your real projects. Or, some excellent salesman convinced you to order a stockpile of the latest and greatest fixtures (or what-have-you) to have on hand for your service clients. And, a year later you still have most of that stock taking up room in your warehouse or yard. You can’t find the things you really want and need because that “stuff” is always in the way.

Time to liquidate the unused product. The cost of keeping it is too great. Think, “If I had the same opportunity to buy this product again (knowing what I know now) would I do it?” If something catastrophic happened and you lost that product would you go out and buy it again? Could it be that the benefits of your choice (it was on sale) decreased over time while the costs (storing it and searching past it) increased? Could it be that you didn’t have all the information when you made the initial decision, but now (with new information) it is clear this product is not serving you in any way? You aren’t saving money, you’re losing money in storage and wasted time searching for what you actually need.

Process

You know and understand that when you put together a process or a system it takes time, money, and effort. Perhaps someone talked you into purchasing and using their system for maintaining the tools and supplies on your service vehicles.

And. It. Doesn’t. Work. It just sort of limps along. No matter how hard you try.

You bought the software, you spent countless hours training your technicians, you spent even more hours on the phone trying to figure out why it wasn’t working.

Does the word, “groan” come to mind? Think, “My goal is to have a great process, not to own a dysfunctional piece of software.” Is it possible abandoning a sunk cost is a sign of good decision making? Are you over-estimating the importance of the sunk cost? Is it possible the lessons you learned while using the dysfunctional process will come into play as you move in a new direction?

Overcome Lost Cost Fallacy

Here are some ideas concerning how you can deal with the Lost Cost Fallacy which crops up in your life and business.

  1. Are you trying to prove you made the right decision in the first place? Is being “right” more important than your business and your bottom line?

  1. Realize that dumping a Lost Cost is in reality a sign of good decision making. It shows you’re good at knowing when to say no and when to move on.

  1. Reflect on things from your past. Did you give up an item of Lost Cost? Aren’t you glad you got out while you could? What good things eventually came from dumping the Lost Cost item?

  1. Ask others. Seek help from your mentors, colleagues, friends, and trusted advisors. People are usually much better at seeing the Lost Cost items owned by others. And some, like your lawyer, insurance agent, and accounting advisor (that’s us) are trained to see items you’re missing when it comes to lost costs and lost causes.

Here at Schulte and Schulte we specialize in accounting for construction subcontractors. We’ve seen a few people limping in with the Lost Cost Fallacy hanging on to them like a child wrapped around and clutching onto his daddy’s leg. When we show our clients that’s not their kid, but rather a naughty dog they learn how to “shake it off.”

#accounting #construction #process #lostcostfallacy #decision #advisors #cost #Subcontractors #money

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610 East Bell Road, Suite #2-612

Phoenix, AZ 85022-2393

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