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Sunk cost fallacy: The ultimate guide

Sunk cost fallacy: The ultimate guide

Imagine starting a movie you’ve been wanting to see for ages. About 30 minutes in, you realize that the plot is all over the place, the acting is horrible and you could have spent that time doing the laundry instead. But you continue watching – because you’ve already sunk time into it and you’d hate to have wasted your time.

This is something known as the sunk cost fallacy and it happens to all of us on a regular basis. However, the effects of this phenomenon are much deeper and more serious than a half hour wasted on a Ben Affleck movie.

Today, we explore sunk cost fallacy – what it is and how it impacts your productivity and decision-making processes.

What is the sunk cost fallacy?

The concept isn’t that old and the term first appeared officially in 1980 when it was coined by Richard Thaler. In essence, sunk cost fallacy happens when we invest ourselves into a certain activity (either with money, time, effort or something else). Even though we can tell this activity is unfruitful, we continue with it because of the investments we made.

In short, we’re too deep into an activity to stop, even though our best interests show that we should abandon it. It’s an irrational behavior that leads to massive losses in time and money every day, from small decisions such as a movie to some really big ones.

From an outsider’s perspective, it sometimes may not make sense why someone is continuing with an activity or project despite it showing poor results. You may have a friend who’s dating someone who’s treating them really poorly, but they can’t break up because they’ve been together for so long - or they can’t stand being alone.  But let’s take a look at this problem at an even bigger scale.

The Concorde fallacy

Besides the name mentioned above, this phenomenon is also called the “Concorde fallacy”. The best-documented example of this principle in action happened in 1976 when the first commercial flight of Concorde took place. This was a supersonic jet for commercial use.

The problem is, the moment it launched, it was obvious that the costs were immense and that Concorde wasn’t profitable. Sunk cost fallacy kicked in and despite getting an injection of 2.8 billion USD in 1976, Concorde went on to waste even more money in the years to come. The project was abandoned completely in 2003 because of how painfully unprofitable it was.

Perhaps the biggest takeaway here is that everyone is susceptible to this fallacy, no matter how advanced the organization might be. The reason the Concorde project lasted for almost 40 years is because it was funded by the French and English governments. And if a group of people of that caliber can make an error on such a scale for so long, we should be even more wary of it in our daily working lives.

What are some examples of sunk costs at work?

Sunk cost fallacy happens to all of us and it’s much more frequent than we would think. In fact, it often happens at work and without knowing it, we spiral down into a black hole of decisions, often wasting time and money and hurting our productivity.

Here are some examples:

  • You’ve spent thousands of dollars on a new app and paid for an annual plan upfront. The product is too complex, you don’t use most of the features, but you’ve invested a large amount of cash and time to train your employees. You continue using it instead of moving on to something cheaper and easier to use
  • You hire a new person on your team and pay out of pocket for the sourcing, hiring process, job boards, referral bonus and more. After a month, it turns out the new hire is nowhere as capable as you thought. Instead of firing and replacing them, you consider the sunk cost of hiring them and instead train them some more, wasting even more time and money.
  • Or even worse, you have an underperforming team member who coasts at work rather than giving their maximum. You know that hiring a new employee costs thousands of dollars, so you decide to keep an underperforming one instead of actually saving money by spending a bit extra on a new hire.
  • You’ve spent $50,000 doing research and development for a new product, only to see it fail miserably with sales upon launch. Instead of giving up, you double down on marketing investments, hoping to reach a larger audience and make a profit.

As you can see, the sunk cost fallacy goes way beyond your decision to eat a really bad pizza just because you paid for it. It can cost your organization immense amounts of time and money every year.

But why does this happen in the first place?

Why we’re so susceptible to the sunk cost fallacy

As humans, we’re naturally flawed and biased and we tend to make irrational decisions. Despite our best efforts to remain objective, sunk cost fallacy creeps in because of strong underlying psychological effects. And no matter how qualified, educated or smart we are, sunk cost fallacy happens to us all.

The first one of them is loss aversion. It entails that the pain of losing something is twice as strong as the pleasure of gaining that exact same thing. In other words, if you lost $50 today, that would have a stronger emotional impact on you compared to gaining that same $50 from someplace else.

In short, we tend to make decisions to avoid making losses rather than focusing on what we can gain.

The second reason is a phenomenon called the framing effect. Widely discussed in psychology, it means that when we end up pushing a decision or activity until the end, we perceive it as a success. If we give up on it mid-way, we frame it in a negative light, even though giving up would be the most logical thing to do.

For example, you start a new employee appreciation initiative, and midway through, you realize your employees hate it. Instead of embracing the logical decision to move on, you push through because if you quit, you’ll perceive it as a failure. In reality, you’re making it worse if you persevere.

Last but not least is something called the overoptimistic probability bias or optimism bias. First mentioned in 1968, the original research involved a group of people betting on horses. In short, people who just placed a bet on a horse had a stronger sense that they picked a winner compared to the people who had not yet paid and placed a bet.

In other words, once we are financially and emotionally invested in an activity, we tend to be overoptimistic about the success of that activity. If we’re not invested in it, we can see the outcomes more objectively.

The one thing that’s in common with all biases mentioned above is that a human being is usually a poor judge of objective outcomes.

How the sunk cost fallacy affects teams

As you can probably see from the Concorde example, this phenomenon can have some very real and costly consequences. Inside the workplace, you can expect the following things to happen.

1. Blown budgets

Since you’re focused on the sunk cost that happened in the past, you continue spending on an unprofitable project.

Instead of considering how much money you lose by going through with a failing project, you focus on the money you already have invested. You think you’re focusing on the long run and persevering but in reality, you’re just making a bad situation even worse.

2. Poor team morale

As your employees work on something that is obviously not going to pan out as you envisioned it, expect them to feel unmotivated about their work. Chances are that your employees are less invested (financially and emotionally) into a project than you are. This means that they can view the situation more objectively.

3. Reduced productivity

You’re working on projects that are not going to contribute to any profit or gains – while you could be changing your focus to something entirely different.

4. Missed deadlines

You’ll prolong working on something despite it not producing any results. You end up working longer on an initiative because you’re too focused on the losses from the past to see the present moment – where you should already be finished.

In short, this logical error can cause immense damage to your team, company and business.

It’s in your best interest to avoid it and today, we’re going to show you how.

How to avoid the sunk cost fallacy

Being aware of it is a great way to avoid sunk cost fallacy, but it’s often harder to be objective than we might think. There are some pretty good ways to prevent sunk cost fallacy from happening in and outside of work, so let’s get to it:

1. Guide yourself with data

Before making a decision, think about the time and money you invested and the outcomes you want to achieve. Moreover, think about the gains you can make by abandoning a project. Using a time-tracking app can be of great help here. If you’re not sure about what deserves your attention, you can use a time management matrix.

2. Use tech whenever you can

A huge part of our bias comes from not knowing how much time, money and effort we spent on something. There are apps that can track your expenses, time and effort spent on certain activities. You’ll also prioritize tasks more easily.

For example, tracking your time with an app like Timely can show you that you spent a great deal of time on a project that’s just not bringing the desired ROI. Besides tracking time, you can add timesheets to show expenses for a specific role. At a glance, you can see how much it costs to run a certain project.

3. Use specific metrics and KPIs to track progress from the start

Choose a metric to track as a sign that a project is heading in the right direction. For example, the return on investment from an ad campaign. As soon as the number plummets, it’s a sign to back out. Note that a goal is not the same as a KPI and that ideally, you want to have both.

As we’re subjective creatures by nature, KPIs help us stay on track as we can follow a hard metric rather than relying on our gut. Especially when you decide on a KPI with a larger group of people, you’ll have more accountability and a more objective viewpoint.

4. Stop being personally attached to projects you’re working on

Easier said than done, but it’s crucial if you don’t want to fall pretty to the sunk cost fallacy. If a project flops, it’s not your personal failure as a human being – usually, there are multiple factors involved. Do not fear failure – embrace it.

Probably the most important thing is to keep in mind the natural human tendency to be biased when making decisions. Once you’re aware of that, all the extra tools listed above will aid you in the process.

Wrapping up

Sunk cost fallacy isn’t just a term you can find in psychology textbooks. It’s also a very real problem that we face everyday and one that costs us significant time and money, whether in or out of work.

One of the best ways to get started is to track how much time you and your team are spending on each task every day. The great news is — you don’t have to do any of that manually anymore.

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