The sunk cost fallacy in business decisions

Key takeaways

The sunk cost fallacy is the habit of continuing something because of what has already been spent on it, not because of what it will return. In small businesses it keeps in-house setups, software and processes running long after a cheaper or better option exists. Good decisions compare future costs only.

• A sunk cost is money or time already spent that cannot be recovered.
• It should carry zero weight in a decision about the future.
• Common traps: custom spreadsheets, half-used software and trained-up staff.
• Ask: knowing what we know now, would we start this today?

What is the sunk cost fallacy?

The sunk cost fallacy is a decision-making error in which past, unrecoverable spending is treated as a reason to keep spending. A sunk cost is any money, time or effort that cannot be got back whatever you decide next. Because it cannot change, it should not influence the choice between future options.

• The hidden costs of doing everything in-house
• Why businesses keep work in-house when it costs more

Where does it show up in small businesses?

It shows up wherever effort has been invested in a way of working. The more personal the investment, the stronger the pull.

• A spreadsheet system someone spent months building.
• Software on an annual licence that few people use.
• A website built on a platform nobody can now maintain.
• A role created around one person's interests.
• A training course paid for a function that could be bought in.

How does it hide in-house costs?

The fallacy hides in-house costs by turning the question from what is cheapest from now on into how do we justify what we spent. A business that paid £3,000 to train an employee in bookkeeping software may keep bookkeeping in-house for years to honour that spend, even if the ongoing hours cost more than an outside service.

• The opportunity cost of doing everything in-house
• In-house vs outsourcing: which model is more cost-effective?

How do you decide without it?

Decide by comparing only future costs and benefits. Write down what each option will cost and deliver over the next 12 months, leaving out everything already spent. The UK government's Green Book on appraisal applies the same principle to public spending: costs already incurred are excluded from the appraisal.

• List the options, including stopping.
• Cost each for the next 12 months only.
• Estimate what each will deliver.
• Choose on that comparison alone.

• Activity based costing for small businesses

When is past investment relevant?

Past investment matters when it has created something still useful: a skill, a working system or a documented process. That is an asset with future value, not a sunk cost argument. The test is whether it lowers future cost or raises future benefit. If it does, count that benefit. If not, ignore it.

What does it cost to keep going?

Keeping going costs the difference between the current option and the best alternative, every year, for as long as the decision is avoided. If a home-built system needs 5 hours a week of upkeep from an employee costing £19.81 an hour, that is about £4,600 a year. If a standard tool would cost £1,200 a year and need one hour a week, the fallacy is costing roughly £2,400 a year.

The original investment does not appear in that sum at all. It was spent the day it was spent.

How do you raise it with the person who made the decision?

Raise it as a question about the future, not a verdict on the past. The original choice may have been right at the time; circumstances changed. Ask what the next 12 months look like under each option and let the numbers speak. Where the decision maker built the thing personally, acknowledge what it achieved before discussing what replaces it.

Which related biases make it worse?

Two related habits reinforce sunk cost thinking in small businesses.

• Status quo bias: preferring the current arrangement because change feels risky.
• Loss aversion: weighing the pain of writing something off more heavily than an equal gain.
• The effort effect: valuing something more because you built it yourself.

• In-house team myths that hide the real cost

What does this look like in practice?

A pattern we see with internal tools: a business keeps a home-built job tracker because a former employee spent a year on it. Nobody can change it, and two people re-key data into it daily. The year of effort is gone either way. The real comparison is the re-keying hours against the price of a standard tool.

• See client work
• BPO Solutions for UK businesses

Sunk cost checklist

Ask these before renewing or continuing anything.

• What have we already spent, and can any of it be recovered?
• What will continuing cost over the next year?
• What would the best alternative cost?
• Would we start this today?
• Who is attached to it, and why?

• The hidden cost audit: score your business in an hour

Next step

Tell us about one setup you suspect you are keeping for the wrong reasons. We will help you compare the future costs in a 30-minute call.