Sunk Cost Fallacy: Throwing good money after bad
Have you ever found yourself buying something expensive because you had spent so much time looking for it? Or did you secretly consider the price you paid at an all-you-can-eat restaurant when thinking about going for another round? Then you have probably experienced the sunk cost fallacy at its best!
The sunk cost fallacy describes when we consider costs or investments that are no longer relevant. It shapes our decisions in an irrational way. Curious how and why this happens? Read on! We will discuss the how’s, where’s and what’s in this article. Also there are plenty of interesting examples described. Enjoy reading about the sunk cost fallacy!
What is the sunk cost fallacy?
The sunk cost fallacy is our tendency to include the value of past costs in a future decision or trade-off. It is a psychological bias that sometimes results in some irrational choices.
Like the pair of jeans that are lying around in your closet but that you never wear. The fact that we once paid a substantial amount for these jeans stops us from throwing them away. Even though we never wear the jeans anymore!
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The sunk cost fallacy is one of many examples of cognitive biases. Cognitive biases are systematic errors in the way humans think. They show how we sometimes make choices that are far from logical or rational. It is the seemingly random beauty of behaviour from a psychological perspective. If you share an interest in these tendencies with me, be sure to check out our articles about the barnum effect, the dunning-kruger effect and which cognitive biases restrict professional judgement.
On the origin of sunk cost fallacy
The sunk cost fallacy, initially coined as sunk cost effect, is first hypothesized in a research paper by Richard Thaler (1980). He challenged the popular belief that people make rational economic decisions, by considering only the options and costs that are relevant. Nowadays, these are called prospective costs, future costs that you still have an influence on. Instead, he suggested that we also take bygones into consideration when making a decision. Bygones could be in the form of money, but also time.
Consider the following example.
“You and your family pay $40 for tickets to a basketball game to be played 60 miles (approximately 95 kilometers) from your home. On the day of the game there is a snowstorm…”
What would you do?
If you are like most people, you would probably still go. An important reason is because you might think that the initial costs of the tickets are a waste of money if you don’t go. Another possibility could be that you feel the need to follow up on your initial decision.
Now imagine the tickets were free. Perhaps you found them somewhere, or they were given to you.
You might choose to stay at home after all. Mostly because there are no initial costs related to the ticket . And when there are no costs, there is also no sunk cost in decision making. Be aware of other sunk investments in this example though. You could feel the obligation to go anyways because you want to do the person a favor that has given them to you.
So, what happens exactly?
Several cognitive biases are underlying the sunk cost fallacy. The magnitude of these tendencies depend on the particular situation or person. Below you will find a short description of them and how they contribute to the sunk cost fallacy.
Loss aversion is a tendency that makes you fear a possible loss. It usually results in more-than-average safe behaviour and decisions. We experience the pain of loss twice as strong as the benefit of gains.
In the case of the sunk cost fallacy, our initial investments could feel like a loss of time or money. Even though they have no rational value anymore, it still feels like a loss emotionally. This causes us to stick with decisions that have a suboptimal outcome.
Framing also plays a role in the sunk cost fallacy. It is about changing someone’s perception by phrasing or visualising content in a certain way. In the case of the sunk cost fallacy, framing the decision to “cut the losses” as a loss of investment makes this a seemingly bad choice. Framing it in a more positive way is also part of the solution for this bias.
So instead of looking at past behaviour as safe choices, you would frame the situation to emphasize the progress made when changing decisions.
The endowment effect is our tendency to attribute more value to products or things we own as opposed to the same thing someone else owns. Decisions that are made often have a personal character to it. Especially when the stakes are high. Taking responsibility over a high stakes decision makes it your decision. Stepping away from earlier made decisions proves to be hard. A reason for this could be the feeling of ownership over a past decision or investment.
Escalation of commitment
Another bias strongly related to sunk cost fallacy is escalation of commitment, also known as commitment bias. It is our tendency to stick with a plan or goal as soon as we committed to the first step. The bias is quite similar to sunk cost fallacy. Where commitment bias is mostly used in sociology and could even be seen as the overarching theory of the sunk cost fallacy.
Status quo bias
Lastly the status quo bias makes us particularly inclined to have things stay the same. The avoidance of uncertainty is something that makes us human. In the case of the sunk cost fallacy this leads to avoidance of other choices. The certainty of failure sometimes feels better than the uncertainty of rewards.
What is a sunk cost?
A sunk cost is a past investment of money, time or energy that can not be retrieved and has therefore been “sunk”. The term “sunk” refers to the importance of the cost that has been made. In rational economics, these costs are not part of the decision making process. In humans however, they still are.
The opposite of a sunk cost is a prospective cost, which are future costs that can be avoided. These are the costs we mostly consider when deciding which choice to make. Examples of prospective costs are potential losses or restocking costs.
Sunk costs are ideally avoided in order to prevent throwing good money after bad. It results in costly projects, wasteful time and some embarrassment.
Sunk cost fallacy examples
One of the most known examples of the sunk cost fallacy is the so-called “Concorde fallacy”. In the 1950’s the British government, together with the French government, funded the development of the Concorde airplane. After a while, it turned out the development was no longer economically lucrative. Both parties found themselves unable to pull out of development, leaving them with high expenses, not to mention the embarrassment.
There are plenty of other examples on the sunk cost fallacy so below we will describe some of them in different domains. It sometimes seems as if the sunk cost fallacy only occurs in economic decisions but nothing is further from the truth, unfortunately.
A house renovation that turned out to be much more expensive than initially thought. The costs already invested are usually taken in consideration when deciding whether to pull the plug, leaving some with higher expenses. The abundance of TV-shows about this topic emphasize its relatability. We just don’t want to feel our time and money was wasted.
Do you have some clothes in your closet that you never really wear anymore? Do you feel like keeping them because they were expensive (or a bargain)? Then you probably have fallen for the sunk cost fallacy yourself. Considering past costs of clothing when you never really wear them anymore can be considered a sunk cost.
So the next time when you are holding that jeans you never wear, try debiasing your decisions. I know, this can be quite hard…
It occasionally happens that you buy some tickets for an event, but it turns out to be a flop. Instead of leaving and spending your time on other activities you’d rather do, you stay. Why? It’s a waste of the ticket I hear you think. As you might already know by now, the ticket price is a sunk cost. Next time when you find yourself in such a situation, think about all the things you could do with your precious time.
Sunk cost fallacy in relationships
In relationships, often it is more about investing time than money. The sunk cost fallacy is at work when people stay in unhealthy relationships. It blurs decision-making and could even result in further detriment. The following examples show you how the sunk cost bias makes its appearance.
As discussed, the time invested in a relationship plays an important part in its fruitfulness. Unfortunately, it is also part of the reason why so many people are still in poor relationships. It is not easy to let go of the energy and time that you already invested in a relationship.The key point here is not to stop investing time and effort into your relationship though. The key point is to consider only the things that matter for future decisions, and let bygones be bygones.
Every person develops and grows throughout their lifetime. This is a process that asks time and energy. Oftentimes, this effort is for the best. Still, we think that the effort we have put into changing our habits should be considered by our significant other. I am not suggesting to disregard your partners’ progress. Praise her or him for developing! But do not let the past investment of energy blur your thoughts of the future.
Business decisions are high-stakes decisions. There is a lot on the line and you take personal responsibility for it. This makes for thought processes that are prone to bias. No wonder so many companies have fallen for the sunk cost fallacy. When our working memory is busy, cognitive biases and heuristics are lurking.
In some jobs, employees and employers go through a tedious process to train the employee. When the employee finally should be ready to work on his own, he is terrible at it. Investing more time and effort in your employee could result in increased costs and decreased profits for the company. Finding other work for the employee might be the better thing to do, even when it feels like you are going against your own nature.
Building projects are like building a stage for the sunk cost fallacy. When expenses go over budget, project managers face a big decision. Should we continue or abort the project? Future costs and benefits are compared and stakeholders are informed. Depending on the awareness of the project manager and the potential costs lurking the project might be aborted. Sadly, this is not always the case. Too often, buildings will still be built while their costs skyrocket. And in the end, there is always someone who pays the price.
Budget for corporate training also gives great opportunities for a bad buy. Imagine paying for a course that turned out to be based on tricks and simple tactics. Not worth your money to say the least. If you would react in accordance with the sunk cost fallacy, you would finish the training without much enjoyment. Perhaps you didn’t even learn anything new.
However, if you would have stopped the course right away, you could have invested your precious time in a different training that would blow your team’s mind. Personally I would suggest one of Neurofied’s renowned custom-made training. Not only do you save time, you get double the initial value in content and use cases.
How to avoid the sunk cost fallacy?
When the sunk cost bias is lurking, potential losses can be enormous. Lost time, effort and money that you would never get back. In order to overcome these costly mistakes, we present you a couple of different ways to arm ourselves against the detrimental effects of sunk costs. Constant awareness is a necessity at all times. Biases and heuristics are often a product of our brain’s lazy tendencies.
1. Consider sunk costs
This might sound counterintuitive but it can give great insights into your decision-making thought process. By recognizing and stating the sunk costs, you use deliberate thought. This deliberate process helps you recognize sunk costs for what they are, and dismiss them subsequently. It is making the unconscious mistakes obvious.
2. Question yourself, and others
Biases like the sunk cost fallacy are results of our brain’s mental shortcuts. They occur when our working memory is busy or temporarily unavailable. By consciously questioning yourself, you activate your system 2 processes, and are less prone to sunk cost influences. A quote from Thinking, Fast and Slow from Daniel Kahneman addresses this point perfectly.
“Subjective confidence in a judgement is not a reasoned evaluation of the probability that this judgement is correct. Confidence is a feeling, which reflects the coherence of the information and the cognitive ease of processing it.”“Thinking, Fast and Slow”, Daniel Kahneman (2011)
3. It’s okay to change your mind
Nowadays there is a lot of emphasis on making a decision and sticking to it. Perseverance is seen as a powerful characteristic and changing your mind has a negative side to it. This is all wrong! Changing your mind is the ultimate example of progress. Realising you haven’t been doing things right and deciding to change is one of the strongest and hardest decisions you can make. It should be applauded!
So, next time you have the feeling you are sticking with a decision just for the sake of sticking with it, I hope you remember these words. Change your mind! A helpful trick here is to surround yourself with people who encourage you to change and develop. And who can see your decision as a part of growth.
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