One harsh reality that many entrepreneurs must never forget to internalize is that no matter how motivated or inspired they are to pursue a business venture, everything in the business world is always associated with the risk of failure and unsustainable performance. Most especially with the gloomy financial circumstances faced today, economic turbulence is expected, and any wave of disruption to a business sector or industry can happen at a moment’s notice.
However, one common challenge that many newbie entrepreneurs face is the sunk cost fallacy, wherein they convince themselves to continue an unprofitable investment, not for its growth potential, but just for the sake that they are already knee-deep in expenses. Of course, that’s not to say opportunities won’t present themselves and turning things around is impossible, but betting on chance is no longer rational thinking but borderline gambling with your investments.
Avoid Falling Into A Commitment Bias
The sunk cost fallacy manifests itself in many ways. Still, the gist of it primarily revolves around commitment bias. Because business owners have dedicated time and resources to the project, they blind themselves with the idea that things will get better when, in fact, there are zero guarantees. And these sunk costs can take many forms, from the more manageable side project to the more disastrous core operations of a business, so it’s best to keep a keen eye to avoid falling into the same downward spiral.
- Bleeds Your Investment Capital Dry: Firstly, commitment bias and forcing a project to work will bleed your investment capital dry because if something offers zero economic benefits and no profit, then don’t expect it to change anytime soon. For example, if you were among the unlucky businesses to invest in exterior renovations when the global pandemic happened, the smart move would be to put things on hold or switch to more cost-effective alternatives like custom awnings or detailed overhangs.
- Harms Your Mental Well-Being: Apart from bleeding your investment capital dry, falling into a commitment bias with a specific project or business venture breaks your mental well-being because you’re surrounding yourself with irrational thoughts and unhealthy thinking. At the end of the day, running a business requires you to be critical, and squeezing your resources for the sake of something that won’t generate profits is the furthest thing from financial soundness. What’s worse, you will find it even more challenging to start over again.
Pay Attention To Key Performance Indicators
One significant disadvantage faced by those falling into a commitment bias and suffering from sunk cost fallacies is that these issues often go overlooked unless you regularly review the objective financial reports of your business. Therefore, we strongly recommend paying attention to key performance indicators regarding your cash flows and balance sheet to prevent anything terrible from holding your business back.
- Address The Profitability Ratio: An excellent place to start is by addressing your profitability ratio, and if the profit margins are much lower than expected despite intervention measures, then the numbers won’t lie about performance. Of course, jumping the gun and cutting off a project is also problematic, so we suggest you call for a meeting to discuss the appropriate action plan with key stakeholders and move forward from that reference point.
- Gauge Relative Audience Engagement: In addition to the profitability ratio, another critical method of weighing the growth potential of a project or business venture is by gauging the relative audience engagement. For example, even though a product or service isn’t as profitable but scores high with customer satisfaction and reviews, then further product development is needed instead of stopping it. Likewise, if the audience engagement is also low, then all the more reason to discontinue.
- Evaluate Current Industry Trends: Lastly, businesses must focus on the internal factors associated with their growth and the external threats that impact decisions like current industry trends. Relevance plays a vital role in customer retention and scaling your operations, but if current trends point toward the exact opposite, then you might want to rethink your resource allocation for that project.
Implement An Effective Exit Strategy
On a final note, we advise all businesses to prepare an during conceptualization because the need to liquidate and cut off an unprofitable venture is something you don’t want to hold onto long-term. And regardless of the number of forecasts and economic outlooks, no one can time nor predict which momentum or trend will follow. So, it’s much better to practice prudence and a conservative nature by preparing for the worst but still hoping for the best to unfold.
Make The Intelligent Financial Decision
In conclusion, anything can happen in this volatile business climate, and chief among those risks include your business falling out and returning losses. And, in the event that you face this issue, please make the intelligent financial decision to liquidate and avoid a sunk cost fallacy.