What is the sunk cost fallacy, and how can start-ups avoid this decision-making error?

The Sunk Cost Fallacy, in German The sunk-cost fallacy, describes a decision-making error in which time, effort or financial resources already invested unduly influence future decisions.

Those involved cling to a project, product or initiative even though continuing with it is unlikely to yield sufficient benefits. The reason for this is often that a great deal of resources have already been invested, and they do not want these investments to have been „in vain“.

Sunk costs are costs that have already been incurred and cannot be recovered. These include, for example:

• development costs already paid
• time spent working
• completed marketing campaigns
• non-refundable fees
• Costs associated with unsuccessful prototypes
• Expenditure on technologies that are no longer usable

These past costs should not be a determining factor in making a rational decision. What is far more important is the future expenditure involved and the future benefits that can realistically be expected.

One example:

A start-up has already invested 150,000 euros in developing a product. However, tests show that potential customers have little interest and do not perceive the underlying problem as urgent.

The 150,000 euros already invested cannot be recouped by continuing the project. The start-up should therefore assess whether further investment makes economic and strategic sense.

Typical signs of the sunk cost fallacy are:

• A project is being continued solely because of the investment made so far
• Negative feedback from customers is repeatedly ignored
• Initial assumptions are not revised, despite new findings
• Those responsible do not wish to acknowledge a previous decision as a mistake
• Additional resources are being deployed without clear performance criteria
• Giving up is generally equated with failure
• Alternative solutions are no longer assessed objectively

This fallacy can be particularly problematic in start-ups. Time, capital and human resources are usually limited. Clinging to an unsuitable product or business model can shorten the financial runway and prevent more promising opportunities from being pursued.

The sunk cost fallacy can occur, amongst other things, in the following situations:

• the development of a product for which there is no demand
• ineffective marketing or sales channels
• inappropriate corporate partnerships
• outdated technical solutions
• unprofitable client projects
• unsuitable staff or service providers
• expansion into an unattractive market

Start-ups can minimise decision-making errors by taking the following measures:

• define clear success and termination criteria in advance
• Review decisions regularly on the basis of up-to-date data
• assess future costs and benefits separately from past investments
• Take on board feedback from customers and external experts
• compare different courses of action with one another
• Clearly define responsibilities for the assessment
• Viewing pivots or project cancellations as part of the learning process

A useful check question is:

If we were to start this project again today, armed with the knowledge we have now, would we do so?

If the answer is ‘No’, you should consider whether an adjustment, a pivot or a complete withdrawal would be more appropriate.

Not every decision to continue with a difficult project automatically constitutes a sunk cost fallacy. Some projects take longer than expected or only yield results in the long term. The key factor is whether there are still sound grounds for expecting success – and not simply the amount invested so far.

innoWerft helps founders to regularly and critically review their business models, market assumptions and development progress. Through strategic brainstorming, market feedback and discussions with experts, decisions can be geared more towards future opportunities rather than costs already incurred.