Using the Sunk Costs Concept to Manage Performance

RJ Morris Business Development, Driving Productivity, Employee Coaching, HR, Retention, RJ Morris, Talent Strategy

Want a little insight into the educational background of your FOT contributor today? I started off as a business major at a state school, took Accounting 101, flunked it, and became an English major. I have a Masters in Irish Literature and work in Human Resources, and today we are going to talk about economics and Sunk Costs.  Seriously.

Sunk Costs provide a great lesson to HR pros for when to cut bait on a performance issue. NBC News might want to pay attention, by the way. Just sayin’. I dig reading avc.com, where Fred Wilson, ran a great description of Sunk Costs:

Sunk Costs are time and money (and other resources) you have already spent on a project, investment, or some other effort. They have been sunk into the effort and most likely you cannot get them back.

The important thing about sunk costs is when it comes time to make a decision about the project or investment, you should NOT factor in the sunk costs in that decision. You should treat them as gone already and make the decision based on what is in front of you in terms of costs and opportunities.

… Let’s say you have been funding a new product effort at your company. To date, you’ve spent six months of effort, the full-time costs of three software developers, one product manager, and much of your time and your senior team’s time. Let’s say all-in, you’ve spent $300,000 on this new product. …

Now let’s say this product effort is troubled. … You think you can fix it, but that will take another six months with the same team and same effort of the senior team. In making the decision about going forward or killing this effort, you should not consider the $300,000 you have already sunk into the project. You should only consider the additional $300,000 you are thinking about spending going forward. The reason is that first $300,000 has been spent whether or not you kill the project. It is immaterial to the going forward decision.

It is very hard to actually forget about the initial investment and focus on future performance. We do the same with talent, especially when we have a long-term employee with performance issues. Check how this challenge plays out:

– Bill from sales was our top salesperson 5 years ago. We love Bill. Bill is one lucky break away from getting back to winning the “silver hammer” sales award. We’ve trained him and stuck with him through the rough years… it’s bound to change…

– Tom, the high potential guy who we sent to Chicago for his MBA. We all think he can be the next COO, just as long as he can control his drinking. But you know, he just went through that nasty divorce, and we’ve invested so much into him…

– Sally, tech expert in engineering. We want her to lead that group, and she’s had management training, and we even got her a coach. She’s so good technically, but her style is abrasive. We need her to take over for Stan; we don’t have anyone else…

This stuff happens all the time. The key is to get the focus on what future costs and what future return will be. What is it going to take to get future return on future money? When figuring out how to invest in a turnaround, remember the sunk costs concept.

RJ Morris
I have spent the last 20 years of my professional life advising leaders to make great talent decisions to drive business results. In my current gig, I lead talent acquisition and management for a multi-billion-dollar, 100% employee-owned construction company. I geek out on analytics, succession planning, etc. and love it when we position folks to do their best work. That’s fun stuff. I tease bad HR people, because I think we can all do better, myself included. That’s fun, too.