Us humans are usually irrational critters a lot of the time.

Sometimes the higher priced item is more appealing simply because it’s higher priced. But that’s another post. Sometimes it’s hard to pull the trigger to buy something because of the fear of buyers’ remorse. But likewise: another post.

This is about sunk cost and how it can change the way we act. We see this all the time in the current real estate market. I see it in business too. What I’m talking about is how you deal with something actively changes based on how you got it in the first place.

If, for instance, you buy a house (House A – your current house) for $200,000 and now the real value is $175,000 you don’t feel like selling it. Even if you want to move and you can effectively “trade” your house for one that better fits your needs that costs $175K now (House B – the other house). (I’m assuming that for the most part both of the houses moved in sync with each other) Excepting transaction costs (admittedly not insubstancial) if you would have bought house B originally, you’d be better off now because you would be in the house you want now. Financially you’d be no worse off. What prompts you to not sell house A? The fact that you paid $200K for it originally.

If someone gave you house A you most likely wouldn’t have the same emotional attachement to it. But since you paid the cash, somehow it’s admitting that you might have been wrong originally. Most people have a hard time accepting the sunk cost of buying house A and making the rational decision to just sell it at market value.

The same thing happens in business. If you spend $10 to market to someone (person A) to get them into your door or web site you have $10 worth of attachment to that person. If you spend $20 on someone else (person B) are you going to treat them any different from the first person? Why? You already spent the money — the sunk cost — now you just have to figure out how to make the next best move. Person B could have been a hot prospect at first glance, but as you learn more about them person A might be better. If, after you know this, keep pestering B, you’re spending good money/time after bad. Treating B like they are “worth more” than A is a fool’s game. You got ’em both, now deal with it. One’s a lemon, make lemonade — even if it’s B.

Progressive Insurance made a killing on this very idea (in several different ways, but I’ll only deal with one). When they first started doing the comparative rating where they show you their rate and the rates of their competitors. They went into this with some commitment — that they knew how much that consumer would cost to insure. If they were the cheapest it’s because they could charge that price and still make money. If someone else was cheapest then just tell the consumer to go there — it’ll cost the other company more anyway. It’s a win-win scenario: either they make money, or the other guy loses money.

It doesn’t matter how they got the consumer. They were happy with this in any case. And why not?

Every situation stands alone.

Divorce yourself from the back-story of how you got to where you are and figure out where you need to go. Then try to do it.