Don’t get caught in the whirlpool of throwing good money after bad!
Do you have a project that you started that hasn’t achieved results yet? Are you are still investing in it? Sometimes companies get caught up in spending money trying to save a project by “throwing” more money at it. These projects have sunk costs— money (and money-equivalent expenditures) invested in this project are gone—you can’t get them back and so they are considered “sunk costs”. Advertising is an example of a sunk cost. Once you’ve spent the money it can’t be recovered.
Did you know that psychologists have proven that people would rather avoid losing a dollar than spend new money investing in something that might be a gain for them? It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining. People are more willing to take risks to avoid a loss than to make a gain. (“losses loom larger than gains” Kahneman & Tversky, 1979) This concept is at work in companies everywhere.
For example, I worked in a company that needed a fairly customized software solution to provide long-term services to its business customers for a particular type of HR program. We defined our requirements at a high level and invited the software development companies in that market (with existing platforms) to respond with bids. Ultimately, we decided to handle the project internally since we were trying to integrate all of the functionality of several older applications into a new streamlined tool. We had a sophisticated IT dept. that was used to developing solutions from our sales side.
We were not a software development company, so this was not our core competency! We were “super” users of the various functions needed for this software. When we originally identified our need for this new tool, there was no existing version in the market. We had programmers and business requirements team members available, so we decided to develop a tool on our own (based on a ROE calculation). Every quarter the project leaders (Senior execs of the operating divisions and the IT Dept.) would review the project status with the Division CEO. Reports and presentations noted whether we were on track for deliverables, expenditures, issues, etc.
We spent almost $300k on this software development project after 18 months on the project. At every meeting, the project team wanted to continue with the project. Give it more time! We’ve already spent $1mil on development and we need a customized tool. Also at every meeting, the CEO asked Is there another alternative? Shouldn’t we start over with a different approach?
Finally, the CEO asked us to formally re-evaluate the project. How to proceed? First, we had to let go of the money that had already been spent. It was gone. To move forward, the sponsoring team had to disassociate themselves from a win or loss position and move forward as if none of that had happened. Fortunately, our culture was not one where “heads would roll”. The question was whether the original plan had merit or whether an alternative solution would be best. If there was value in the original plan, how much will it cost going forward to get to a viable tool? Are the benefits of a customized tool worth the costs that will be incurred from now forward OR is there a different tool or solution that we should explore that would result in a better return on a new investment.
As it turned out, by the time we this far into project, one of the specialized software development companies we had asked to propose their solution had moved to a more flexible platform and proposed providing a customizable solution at a reduced cost.
Ultimately, we decided to abandon the inhouse software and migrate to the new 3rd party software solution. While it was painful to admit that we had spent over a year and $300k on the investment, it would not have been a wise decision to continue with that project. The Result: we were able to start testing parts of new software within a few months of giving the go-ahead to the 3rd party provider. Plus, the groundwork in developing our requirements for our in-house solution made the transition much faster.
Do you have a project you have invested in that you might need to reevaluate? If you’d like to discuss how your solution improves the value of your company or doesn’t, or if you’d like to discuss your company’s readiness for sale, please let us know. In the meantime, if you have questions or comments, I can be reached anytime via email: [email protected] or phone at: 224-688-8838. We’re here to help you Harvest Your Potential.
