What is the sunk cost fallacy? It is where people are reluctant to abandon a course of action because they have invested a lot of time or money in it, despite abandoning it being the most logical choice.
In economics, a sunk cost is a cost that has already been incurred and cannot be returned. These costs don’t have to be money. Examples of sunk costs are the money and time it cost to set up a new branch in a business, the money and time spent researching a new type of plane, the money you have spent on a movie theater ticket. Anything that you have put into an action or a strategy is a sunk cost because it cannot be taken out. If you are halfway through a book, the time you have put in to get that far is a sunk cost because you cannot get it back.
The sunk cost fallacy comes in when people keep doing something that has no logical reason because of the time or expense they have sunk into it. With the book analogy we just used, think about a book you really aren’t enjoying. Many of us have got halfway through a book and realized that we don’t want to read it anymore, but we force ourselves to finish it. We think, “I’ve come this far through it, I have to finish it.” That is the sunk cost fallacy. The fact that we have spent time reading the book has, logically, no bearing on whether or not we force ourselves to keep reading it. All that should matter is whether we want to read it or not.
The sunk cost fallacy is often called the Concorde fallacy because the plane is a perfect example of it in action. The idea for a supersonic jet was hatched between France and Britain in 1956 and work commenced. The first commercial Concorde flew in 1976. At the start of the project, it had been projected to cost $100 million, but by 1976, $2.8 billion had been invested by the British and French governments. The plane cost so much to run and maintain, that it was never going to be profitable. In that situation, the logical choice would be to drop the project because it will cost far more to keep running than has been lost so far, but people can only look at how much has been invested and the projects continue. It turns out that British Airways was able to turn a small profit every year, but France could not. And this small profit was nowhere near enough to cover the costs.
In business, making decisions based on sunk costs is not a good way to be successful. When making financial decisions, businesses have to think about the costs and the revenue that will change. How much will come in and how much will go out. The money that has already been spent, the sunk cost, will not change and should not be part of the decision thinking.
The sunk cost fallacy can stop people and businesses from moving away from ideas or projects that aren’t working and finding something that could work. If we only focus on what has gone in, we will never be able to give up the project. Any logical decision about a project should only look at the current situation of the project and its future prospects.
So, why do we think like this? It is a form of cognitive bias. The first reason we do it is because we hate losing anything, be it time, money, or effort. If we have spent $100 on a theater ticket, but we don’t want to go because we are tired and stressed, the sensible decision would be to not go to the theater. However, we can’t stand to lose $100, so we will make ourselves go. This is mistaken thinking though, because the $100 is already spent. You cannot lose what you have already spent.
The second reason is the fear of failure. If we have invested a lot of time and money into a project, but we can see that it is not taking off, the logical decision would be to drop it and do something else. However, if we drop something, we feel that we are giving up and that we have failed. Many people cannot stand this feeling, so they continue doing something long after it has any chance of success.
The third reason is that we are all extremely optimistic. When we are working on a project that is not going well, we think that it will probably start to get better soon. If we just keep going, it will improve. We look at all of the effort we have sunk in and keep going in blind optimism.
The fourth reason is that we don’t want to be wasteful. If we have bought that $100 theater ticket, not going seems wasteful and we have all been brought up not to waste anything. And this is what I learned today.
Photo by RDNE Stock project: https://www.pexels.com/photo/confused-man-looking-at-the-laptop-screen-6517090/
Sources
https://www.investopedia.com/terms/s/sunkcost.asp
https://thedecisionlab.com/biases/the-sunk-cost-fallacy
https://asana.com/resources/sunk-cost-fallacy
https://en.wikipedia.org/wiki/Cognitive_bias
https://en.wikipedia.org/wiki/Sunk_cost