How to prevent ‘sunk costs’ from sinking your decision process

Why you should consider only the future consequences of a decision and let the past and any 'sunk costs' go

On a recent trip to Sicily, Howard Schultz, the founder of Starbucks, was introduced to the Mediterranean custom of downing a spoonful of olive oil every day. After observing the local practice, he decided to take up the ritual himself, enjoying a dose of olive oil alongside his morning coffee.   “I was absolutely stunned at the unique flavor and texture created when the Partanna extra virgin olive oil was infused into Starbucks coffee,” Schultz said.[1]

Schultz’s moment of inspiration sparked a year-long product development process culminating in the release of the Oleato: Starbucks coffee infused with Partanna extra virgin olive oil.  At the product launch event Schultz called the new line of coffee a “game changer,” saying, “This is a transformational moment in the history of our company -- creating a new category, a new platform.”[2]

Shortly after the launch, Schultz handed the reigns of the company over to his hand-picked successor, Laxman Narasimhan, and it became Narasimhan’s responsibility to roll out the Oleato product and get customers excited about olive-oil infused coffee.

Starbucks invested millions of dollars importing olive oil and on marketing events to promote the drink.  There was only one problem, nobody wanted olive oil with their coffee.

As one critic pointed out, “Hey, I love both of those things separately, but putting them together is like mixing oil and…. well, like mixing oil and coffee.”[3]

Fast-forward a year.  Starbucks sales and profits are in a downward spiral and Narasimhan is replaced by Brian Niccol, the former CEO of Chipotle.  One of the first things Niccol did was cancel the unpopular Oleato product line.

The question is: Why did it take a year to pour the Oleato down the drain?  The Wall Street Journal reported that some stores were selling only a handful each week.[4]

One factor likely keeping the Oleato on the menu at Starbucks despite clear signs that it was a failing product was the Sunk Cost decision trap, one of the powerful decision traps we explore in Decision Mojo, a learning laboratory focused on improving decision-making.   This trap is our irrational tendency to include costs in our decision-making calculus that have already been spent and cannot be recovered.  From a rational standpoint, we should consider only the future consequences of our decision – any costs incurred prior to making our decision are largely irrelevant.

The problem is, of course, that we are human, and we have emotions.  We become emotionally attached to investments we have made, even though we should rationally only consider future prospective costs and consequences when making a decision.  Yet our judgment is clouded by a feeling that we will somehow be losing the money, time, or effort already spent – what is called “loss aversion” – even though we won’t lose it any more or less at this point, and spending more money, time, or effort won’t likely create success.

We feel for Narasimhan, who possibly wanted to cancel something that was the brainchild of the founder.  But he was also the one who had subsequently invested millions in marketing and product development, and thus no doubt felt the emotional pull of sunk costs.

Niccol, on the other hand, hadn’t been the one making the investments and was less subject to that emotional pull.

While there are several great techniques for avoiding the negative decision-making effects of loss aversion and the Sunk Cost trap, one especially powerful technique was described by Andy Grove, the long-time CEO of Intel during its period of dominance as a leading maker of micro-chips.

At the time, Intel’s primary business was memory chips, where it had invested heavily over a number of years and had a dominant market position.  However, it was now facing severe competition from Japanese technology companies.  At the same time there was a small but promising market for processors that ran micro-computers.  Grove and Intel’s chairman and CEO Gordon Moore were considering a strategic decision to exit the memory chip business and enter the micro-processor business.

“I remember a time in the middle of 1985 … I was in my office with [Gordon Moore] and we were discussing our quandary. Our mood was downbeat. I looked out the window at the Ferris Wheel of the Great America amusement park revolving in the distance, then I turned back to Gordon and asked, “If we got kicked out and the board brought in a new CEO, what do you think he would do?” Gordon answered without hesitation, “He would get us out of memories.” I stared at him, numb, then said, “Why don’t you and I walk out the door, come back in and do it ourselves?”[5]

That’s exactly what Grove and Moore did.  And once the decision was made, many of their partners and suppliers were cheering them on, asking, “What took you so long?”  People who were less emotionally invested in the memory chip business could see much more clearly that continuing to invest in that business would likely be a losing proposition.

Grove calls this adapting an outsider’s perspective:

“If existing management want to keep their jobs when the basics of the business are undergoing profound change, they must adopt an outsider’s intellectual objectivity. They must do what they need to do to get through the strategic inflection point unfettered by any emotional attachment to the past. That’s what Gordon and I had to do when we figuratively went out the door and came back in.”

The next time you or your team face a decision of whether or not to move on from a project where significant investments of time and money have been made, don’t wait for someone else to step in and make a better choice unencumbered by the Sunk Cost trap.  Rather, ask yourself, “What would I do if I was hired into this role today and faced a decision on whether to continue investing in this or put our investments somewhere else?”

You might find, like Niccol, Grove, and Moore, that the answer is staring you in the face.

Sources:

[1] Starbucks website

[2] CNBC

[3] Ted Goia

[4] Wall Street Journal

[5] Only the Paranoid Survive: How to Exploit the Crisis Points That Challenge Every Company by Andrew Grove.