How To Keep Sunk Costs From Sinking Your Business

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This article was originally published on Forbes.com.

Offering below-market base salaries while paying out aggressive, above-market 20% quarterly bonuses based on personal and professional goals makes sense for a performance-based company, right? We certainly thought so, and we invested a lot of time in selling this method of compensation internally as a key differentiator in our early days.

Unfortunately, applicants were wary of taking a cut in base salary and didn’t trust promised bonuses. When we realized we were hindering our recruiting efforts by sticking with a system that didn’t match the market need, we decided to shift most of the quarterly bonus into more competitive base salaries and deal with underperformance differently.

Almost overnight, the headache of trying to explain our compensation system to candidates disappeared, and we hired some of our best people, who felt our compensation matched the market.

According to the sunk-cost fallacy, when we invest in a solution, it’s hard to give up on it — even when the ongoing costs outweigh the benefits. Focusing on how much time and energy we’ve already spent on something (rather than how it’s working) distracts us from making good decisions.

Stop Investing To Get People To “Average”

From training and development to salary and benefits, employee investment is high-dollar and high-return. But continuing to waste energy and resources on someone who isn’t a fit — or who chronically underperforms — does a disservice to both the company and the employee.

Three years ago, if an employee wasn’t working out, a multi-month discussion and process would have ensued before we took corrective action. Now, we’ve learned to identify performance indicators early in the training and onboarding process that tell us who will or won’t succeed in our culture.

History has shown us that how people start out at our company highly correlates with their long-term success, and the first couple of weeks are extremely predictive. If a new hire struggles right out of the gate with keeping our pace, learning critical concepts or mastering the client-service dynamic (all strengths that our best people possess) we don’t wait or hope it will get better. While it’s tempting to believe we could invest in these areas, past experience tells us these individuals rarely find long-term success in our environment. Their strengths lie in other areas.

Rather than prolong a painful situation, it’s better to minimize wasted resources and help an employee transition to a better fit elsewhere. Use training to make the best people better rather than get someone to “average.”

Measure New Ideas Like An Investor Would

While new ideas and innovation are essential to long-term success and growth, it’s also critically important to map milestones that objectively measure success along the way. To ensure a project meets its goals, we create objective, measurable outcomes and timelines, much like an outside investor would. Rather than continue to waste money when products or services aren’t gaining traction or hitting incremental goals, we listen to the market.

For example, when my company launched a product called RAMP, it didn’t “ramp up” (pun intended) engagement with smaller companies as we’d anticipated. So we put the rollout on hold for a year to explore different approaches. After stepping back and taking a fresh look at the problem, we relaunched the service in a new form. Using the parts that worked — and leaving out what didn’t — will result in a more promising offering for the market.

By comparing forecasts with actual numbers at regular intervals, you can stay on top of results and get an early read on why they might not be matching up. This allows you to make difficult-but-timely decisions about whether to proceed and where to focus resources.

Fire Your Worst Clients 

When it comes to clients, establishing mutually beneficial and respectful relationships is always the goal. And like all partnerships, it’s a two-way street. Unfortunately, when a client isn’t taking care of his side of the street and drains your company’s resources, it’s sometimes necessary to fire that client and move on. As we’ve learned from experience, something better will come along in its place.

In the past, we’ve provided our clients with code-of-conduct agreements to sign, along with their statements of work. These clarify how we expect to communicate and resolve problems, and also set expectations of accountability to ensure that our partnership remains as respectful and productive as possible. When these things weren’t clearly disclosed and agreed to up front, our team sometimes ended up doing more work than originally agreed upon, exhausting themselves trying to reach an ever-shifting goal.

After kicking off your partnership with a dialogue about the scope of work, focus on how each side intends to approach the working relationship. If a client isn’t willing to put in effort at the beginning, it almost always indicates that issues will arise down the road.

Choosing to end a client relationship, put a product on the back burner, or let an employee go can be agonizing. But, time and again, we’ve made the difficult — and sometimes frightening — choice to refocus our resources and stop the bleeding in terms of cost or energy. We’ve seen the payoff in increased productivity, profitability and client satisfaction.

Don’t buy into the sunk-cost fallacy. When things aren’t going according to plan, aligning your response with your long-term business objectives is not only key to your company’s success, but also to its survival.

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