The best lesson learnt while studying Finance

mba-financeI recently completed one more subject in my MBA course – Finance. So I thought it would be great sharing a small yet very important nugget that I learnt during this tenure. To make the post simpler I decided to just pick one term that I think is my best takeaway from the course. And to surprise you a bit I would like to highlight two simple things about this term. One this is not a long Finance theory it’s just one single term used in every day life, and two it’s not even related to Finance! Yes that’s true. Though you will find it in Finance and Economics books, this term applies more to attitude and life in general. Yes it can also change a lot when it comes to finances in your life and your business.

Define: Sunk Cost

So what is the word? It’s called the “Sunk Cost”. By mere definition Sunk Cost means a cost that has already been incurred and can’t be reversed. You have already invested enough in any activity that you start believing the same can’t be backed out. Though it might seem just a term, if thought judiciously it has great importance in our businesses and personal life.

The Sunk Cost fallacy and why leaders fall prey to it

How many times you have continued an activity, though you felt that it’s a complete failure, but you still continued just because you thought you have already invested so much in it. Backing up half way ‘seems’ foolish, but reaching all the way to realize you won’t achieve the goal is ‘always’ foolish.

business-sunk-costSunk Cost fallacy is a bigger risk when it comes to Managers, Strategists and leaders. They define the vision and guide nations to new avenues. After investing considerable amount of effort in any activity we try to foresee the success or failure of the project as our own success or failure. We start owning the outcome.

This lends us develop an ego and a strong desire to prove that what we thought initially was right. This confusion and an ego to prove to the world we are never wrong, makes us invest our effort in something which is than bound to fail and perish all our goodwill. We act irrationally in such scenarios and overlook even things that are termed common sense.

Some examples of Sunk Cost

Apart from your own examples (Ok don’t fool your self there are plenty examples when you goofed up). One of the real examples of Sunk Cost that the world noticed was George Bush’s stance on the Iraq war. The activity started as a war over terrorism but halfway through America already paid a big price for it. Neither the intentions nor the outcome of the war was clear. To this when asked of withdrawing troops Bush replied that American’s owed to those who gave their lives in the Iraq war and the battle just can’t be stopped as it would be an insult of the patriots. The result 250,000 more soldiers were wounded and some even died in vain, while Bush proved to be a victim of sunk cost fallacy.

Finally Is it really a sunk cost dilemma?

So now we are pretty clear that we need to prevent our selves from the sunk cost fallacy. But before getting into the how to of it, it’s more important to understand whether the situation is really a sunk cost dilemma to be termed.

To term something sunk cost and leave when you are just ready to achieve by one more blow is the biggest mistake, but at the same time being too much positive and assume that someday you will reach your goals is again self defeating. One needs to have an eye on details and a vision clear enough to judge whether one should continue with the task at hand or leave. At the end of the day its about how clear one is about the situation and how open he is to criticism.

So, all in all, this was the Sunk Cost Demystified for you as part of the ‘MBA Mondays’ post. Hopefully will take this post further and try to put forth more learning on the sunk cost. Up until then keep enjoying these business articles and do share with your gang!

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{ 1 comment }

Bella Grilli November 30, 2010 at 1:59 am

That is certainly some inspirational stuff. By no means knew that viewpoints could be this varied.

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