Sunk Cost Fallacy: The idea that an organization is likely to continue with a project if they have invested a lot of money and effort in it even when continuing is not the best thing to do.
Economists point out that the sunk cost fallacy is irrational and can be described as “throwing good money after bad”.
I had a conversation with a CIO of one of our Group and Voluntary Benefit carriers in the US where we discussed how easy it has been for carriers to make the wrong core system selection and the resulting damaging consequences. We both knew carriers that had made wrong system selections and then proceeded to make their wrong decisions a lot worse because they didn’t step back, re-evaluate and take the pain of addressing the mistake early, i.e. stop and abandon the project. What starts as a new system selection and implementation continues as an elongated and expensive IT services project focused on trying to fix a fundamental problem of the core system not being fit for business purpose.
There are many reasons a carrier may initially choose a core system and vendor, such as product fit, technology fit, license price, vendor relationships, vendor size, partner eco system, etc. It often depends on the carrier’s size, business lines, organizational makeup and their ranking of the important product and vendor criteria during the selection process. Investing in the evaluation process and taking enough time to be sure you get this right is totally justified. Getting to properly understand a core system and the vendor before cementing a decision into a long-term commitment really does make sense and when this is done well there will be very positive results.
Let’s face it, carriers in today’s life, accident and health industry tend to have very old and complex legacy core system environments that are no longer fit for purpose. The industry paradigm shift forcing the replacement of these legacy systems with a modern digital core system platform is a high roller decision and subsequent investment which has serious consequences for the longer-term strength of the business.
Carriers often validate their selection of a core system and vendor through an additional evaluation step of a ‘discovery phase’, i.e. a post-selection and pre-implementation phase that enables the carrier’s business and IT teams to go deeper in their evaluation before making a full commitment. This step is used to reconfirm the business case and identify new opportunities for the system that may not have been thought of or investigated during the selection process. A strong validation process will mean a fast implementation, strong business adoption, the shortest time to a healthy return on investment and, most importantly, a strong partnership with a trustworthy vendor you can rely upon.
The wrong selection dilemma and what to do next
What should a carrier do if they discover during an implementation that they have selected a core system and vendor that is not going to meet their needs? Do they cut their losses and “fail fast” or do they double down and invest more money for a longer time trying to fix their mistake? Given the enormous pressure on the business for fast results, you would think the former but unfortunately a carrier can decide to stick with their selection decision for far longer than makes rational or economic sense. Effectively they try to fit a square peg into a round hole and, sure enough, they experience the sunk cost fallacy, throwing good money after bad.
Why are wrong selection decisions not nipped in the bud when the tell tales signs emerge? How come it can take years and millions of wasted dollars as well as crucial opportunity cost to finally realize that a selection decision was wrong? Eventually, at some stage, a business loses confidence in a wrongly selected core system and concludes that the system no longer fits with their needs. But in the meantime, the carrier’s business suffers heavily, in some cases for many years, for investing in this wrong selection.
Trying to fix the problem by extracting money out of the wrongly selected vendor
In addition to throwing good money after bad, carriers who have stuck with a wrongly selected vendor often force the vendor to offer them licence and/or resource price reductions that are so low that the vendor is then unable to invest in future product research and development. This makes a bad situation even worse for the carrier, as the vendor stops innovating and investing in their product and the product becomes the next legacy system. In a situation like this, word gets out and the vendor also loses out on market reputation and future business.
Vendors really need to be mindful about selling vaporware – the next shiny toy, and core systems that are not fit-for-purpose, as they will suffer in the long run. Both parties need the relationship to start positive and to deliver the right results, i.e. the new system implemented, continually updated and an ongoing successful customer vendor partnership.
The negative cultural effect
I’m sure you can think of examples of the sunk cost fallacy – if not in your own organization, then in others. These failed systems are either no longer used or a home has been found for them where the system ends up supporting a fraction of the business originally intended. These failed systems usually become a high maintenance expensive ‘custom’ bottleneck.
The result of sunk cost fallacy leads to multiple problems for the carrier – budgets wasted, business lost, relationships damaged, and the company declines. In this age of accelerating digital innovation and increasingly sophisticated customers and employees, mistakes do happen – recognize this fact and embrace it. Fail quickly and take the valuable learning experience. Don’t become irrational, political, or just pig stubborn by going down the sunk cost fallacy road.
Carriers who fail quickly have high trust environments, good leaders and strong learning cultures. These carriers are likely to be the ones who experience the most innovation. Those who go down the sunk cost fallacy road do not enjoy a similar culture and leadership and their people will either jump ship or stay and play the politics game while keeping their heads down. Unhealthy. Looking in from the outside we ask how this happened and how did it go on so long and cost so much? But when you are on the inside of a big organization it can be easy to fall in with prevailing direction.
Failure is part of learning – so use it to grow
Put your focus, time, and investment into making the right selection, but if you accidentally make the wrong selection and the realization hits, then react quickly – fail fast and take the learning forward to your next evaluation. There’s enormous benefit in taking the lessons learned, not to mention the time and money saved in addressing the problem, no matter how much has been spent already. At the end of the day a strong healthy organization means you get things right more often and when you fail you learn – this must be the focus of great leaders.
“One thing is certain in business: you will make mistakes. When you are pushing the boundaries, mistakes are inevitable. How you REACT is important.” – Richard Branson