“Faced with the choice of changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof.”  

~ John Kenneth Galbraith

In our last post, we discussed the fallacy of logic caused by concentrating on sunk costs in the context of the legal industry as a whole. In this post, I will discuss how this fallacy plays into the management of value-based billing arrangements and portfolio-based legal project management.

As a quick reminder, a sunk cost is a retrospective cost that cannot be recovered. The problem with concentrating on sunk costs is that it has a tendency to encourage us to stay the course, even in the face of overwhelming data that we should revise or even abandon the plan. The study referenced in the last post found a significant increase in this “head down barrel forward” mentality when the respondent’s focus was on sunk costs as opposed to prospective gain.

By no means am I suggesting that sunk costs should have no bearing on decision making. To ignore the costs already invested is as certain a path to failure as concentrating on them exclusively. Rather, balancing a review of the investment against the delivery of prospective gain is essential for good management, particularly where, as here, there is no strong, institutional roadmap for fiscal success.

One thing that can make this easier is concentration on the portfolio, rather than the individual project. For example, looking at a single litigation case, or even a small sample of litigation cases can have a tendency to “draw your eye” towards the investment already made. However, if you’re looking at all the cases filed in a state, a region, or even nationally, different identifiers emerge. Those identifiers include areas of continued waste, overall profitability, and excess cost.

In addition, viewing the entire portfolio can, depending on the circumstance, eliminate the tendency to continue on the path because the project is almost over. I spoke to an aviation expert a few years ago who told me that some private plane accidents are the result of “get-home-itis”, where the pilot ignores his or her training and encounters risks because the thought is “if I can just get the aircraft on the ground as quickly as possible, everything will be fine.” So rather than going around and getting speed and elevation right on landing, they force it and tragedy ensues. But if there is no project end to which sunk costs are attached, the effect of this mentality is diminished.

In an earlier post, I described the concept of kaizen, and how it can be applied to a legal services model. Kaizen is another way to defeat the spectre of sunk costs creeping into your management. Continual assessment and effecting minor changes pulls you away from the morass of sunk costs, allowing for a more honest assessment of the progress and challenges faced by the project, regardless of its size.

The very concept of value-based billing arrangements and project management on the portfolio level is inconsistent with a sunk costs mentality. The concept is to break the cycle of incentivized waste, mistrust, and ever-increasing cost that pervades the legal services industry. Why then would it be prudent to concentrate on what has already been spent as the primary indicator of whether more should be spent?

In addition to the kaizen approach, another approach that many law firms have not been very good at capturing historically is the distribution of cost. I’ve heard many lawyers throw around the term “economy of scale” and then make it very clear that they have no idea what it means. While operational efficiency can be an effect of economies of scale, the terms are not interchangeable. The term economy of scale derives from Adam Smith, who referenced it in the context of distributing fixed costs over increased production through the division of labor. In this context, distributing costs over multiple projects and multiple clients benefits each of them. Some costs will always go up as the demand for production increases. If we assume that a single attorney can suitably handle a fixed number of cases, we cannot increase efficiency and productivity (i.e. carry more cases) by simply doubling his case load. We need to hire more people. But if we increase efficiency along with spreading the costs across multiple clients, the number of people and the roles for which they are hired may change. These economies of scale not only assist with the goals of these types of programs, they help resist continued movement in the wrong direction, because the costs do not seem as heavily invested.

Like all vices, the first step in eliminating the problem of the sunk costs fallacy is admitting when you have a problem. Developing methods and metrics to ensure that your project does not fall victim to this fallacy is essential to success.