How the sunk cost fallacy influences our decisions

Headshot kontributor Caeleigh MacNeilCaeleigh MacNeil24 Oktober 20228 menit baca
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Summary

The sunk cost fallacy is our tendency to continue with something we’ve invested money, effort, or time into—even if the current costs outweigh the benefits. When we fall prey to the sunk cost fallacy, we make irrational decisions that are against our best interest—essentially digging ourselves into a deeper and deeper hole. In this article, learn how to combat the sunk cost fallacy and do what’s truly best for you and your team.

In January 1976, the supersonic Concorde jet went wheels-up for its first commercial flight—after an investment of $2.8 billion from the British and French governments. But even when it became clear that the plane wasn’t profitable, investors continued to pour money into the failing project for another 27 years.

This incident gave birth to the term “Concorde fallacy,” which describes how people continue with failing endeavors because they’ve already invested so much. But more commonly, the Concorde fallacy is called by another name—the sunk cost fallacy. 

What is the sunk cost fallacy? 

The sunk cost fallacy is our tendency to continue with an endeavor we’ve invested money, effort, or time into—even if the current costs outweigh the benefits. And while the term sounds like technical jargon, it’s a common decision-making pitfall in both life and business. The sunk cost fallacy can describe trivial things like continuing to watch a boring movie you’ve purchased, or more serious matters like refusing to pull out of a failing business investment. In common terms, the sunk cost fallacy is often called “throwing good money after bad.” 

Whenever we fall prey to the sunk cost fallacy, we make irrational decisions that are against our best interest. And since this tendency is so deeply ingrained in human behavior, it’s important to understand how the sunk cost fallacy works so we can make good decisions based on logic—not dig ourselves into a deeper and deeper hole.  

What is a sunk cost? 

In economics, a “sunk cost” is an expense that’s already been incurred and can’t be recovered. Think of a sunk cost as a past cost you can’t get back, like money you’ve put into a business project or time you’ve spent in a relationship. In a logical world, sunk costs aren’t relevant to our future decisions. That’s because our decisions should be based purely on estimated future costs and business goals, not old investments that can’t be reversed. 

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History of the sunk cost fallacy

The sunk cost fallacy is a type of cognitive bias, a thinking error that makes us misinterpret information and affects the decisions we make. Psychologists Amos Tversky and Daniel Kahneman first coined the idea of cognitive bias in 1972, laying the foundation for further research into the sunk cost fallacy. In 2002, Kahneman won the Nobel prize for his work on cognitive biases in business decision-making, including the sunk cost fallacy. 

Over the years, behavioral scientists and economists have tried to pinpoint why the sunk cost fallacy happens. Richard Thaler first introduced the sunk cost fallacy, concluding that people have a greater tendency to use a good or service when they’ve invested money into it. Later, scientists Hal Arkes and Catherine Blumer expanded on Thaler’s hypothesis when they published an article on sunk costs in the journal “Organizational Behavior and Human Decision Processes.” Arkes and Blumer conducted a series of experiments that illustrated the psychology of sunk costs in action—specifically how the idea of sunk costs influences our decisions. Hint—it affects us more than we realize. 

For example, one questionnaire study asked participants to imagine they had accidentally booked two ski trips in one weekend—one $100 trip to Michigan and another $50 trip to Wisconsin. Even though the researchers told participants they’d enjoy the Wisconsin trip more, the majority of people still said they would go on the Michigan trip. After some mental accounting, participants chose the course of action with a greater initial investment—even though they wouldn’t enjoy it as much. 

The psychology behind the sunk cost fallacy

Researchers in behavioral economics have identified at least five psychological factors that feed into the sunk cost effect:

Loss aversion

Loss aversion is the tendency to avoid losses because the idea of losing something is more psychologically powerful than the idea of gaining the same thing. For example, winning $100 feels good—but losing $100 feels horrible. As a result, we’ll go out of our way to avoid losing $100, even if that means sacrificing our chance to win. With the sunk cost fallacy, loss aversion makes us stick with poor investments because we don’t want to feel bad about losing. 

The framing effect

The framing effect happens when people pick options based on whether they’re framed in a positive or negative light. This effect plays into the sunk cost fallacy because when we follow through on a decision, we can frame it as an overall success. And when we don’t follow through, we often create a narrative of failure—even if cutting our losses was actually the logical choice. For example, imagine you’ve decided to create a blog campaign. Midway through, you realize the blogs aren’t getting the traffic you expected and you’d be better off investing your remaining money in paid advertising. But in your mind, that would mean your blog campaign was a failure—so you decide to follow through, even though your money would be better spent elsewhere. 

Unrealistic optimism

Unrealistic optimism occurs when people believe they’re less likely to experience a negative event than other people. With the sunk cost fallacy, this means we’re likely to overestimate our chances of winning and underestimate our chances of losing—especially if we’ve invested money in something. For example, if you funnel thousands of dollars into a new business investment, you’re more likely to believe it will pan out—regardless of actual evidence. 

A sense of personal responsibility

When you feel responsible for previous expenditures, you’re more likely to fall prey to the sunk cost fallacy. In other words, it’s relatively easy to change a decision made by someone else, but a lot harder to discontinue a project you’ve personally decided to invest in. As such, the sunk cost fallacy is most problematic for project creators and decision makers—in other words, anyone who has a vested interest in the project’s success.

A desire to not appear wasteful

Decision-makers may continue with poor investments because they feel bad about wasting money. For example, imagine you’ve bought a ticket to a movie—but 30 minutes in, you absolutely hate it. You stay for the whole boring ordeal for two reasons: You don’t want other people in the theater to think you’re wasting money, and you personally feel bad about wasting money. The same concept applies when you keep using a software tool you’ve purchased even though it’s not working for your team—you don’t want to waste your investment, so you stick it out. 

Examples of sunk cost

A sunk cost is anything you’ve invested that can’t be recovered. Here are some sunk cost examples to help you identify situations where you may be influenced by the sunk cost fallacy. 

Sunk costs can include: 

  • Opportunity costs, like time you’ve invested that you could have spent on something more productive

  • Effort, like tasks that are particularly challenging

  • Mental strain, like worry you’ve experienced

  • Facilities and overhead

  • Materials and equipment

  • Investments, like purchasing a business

  • Annual subscriptions

  • Non-refundable business costs, like legal fees or advertising costs

Is the sunk cost fallacy really so bad? 

In short, yes. When we let the sunk cost fallacy influence our decisions, we often make bad choices that hurt us. Instead of using logic, we fall prey to a vicious cycle that often includes an escalation of our commitments—we continue to invest time, money, and energy into something, even if it’s not in our best interest. The more we invest, the more committed we are—and the more resources we funnel into that initial bad decision. 

How to avoid the sunk cost fallacy

Luckily, the sunk cost fallacy isn’t a done deal. With these strategies, you can make rational decisions based on logic instead of cognitive bias.  

Be aware

Just being aware of the sunk cost fallacy is a great first step to avoid its pull. So if you’ve read this far, you’re already less likely to make irrational decisions. That’s because when you understand how the sunk cost fallacy works and the different psychological factors that feed into it, you can check for cognitive biases each time you make a decision. 

To do this, ask yourself the following questions: 

  • What am I afraid of losing? How is that fear holding me back? 

  • How have I defined failure and success for this situation? Do those definitions make sense? 

  • What is the actual probability that my endeavor will succeed?

  • What would I do if someone else had decided to invest? What advice would I give to a friend in my situation? 

  • Am I afraid of appearing wasteful, either to myself or others? Is that fear rational? 

Make data-based decisions

The sunk cost fallacy defies logic. Luckily, that means the best way to combat this thinking trap is to bring logic back into the equation by collecting data to inform your decision making process

Here are a few ways to ground your decisions in real-life data:

Set goals before you invest

Before you invest resources in a new project, identify the specific success metrics you want to achieve. Setting measurable goals up front gives you a clear target to aim for and a way to measure success. That means if your project isn’t meeting its goals, you have a data-backed reason to adjust your approach—or simply move on. 

There are a couple different frameworks you can use to set effective goals, including Objectives and Key Results (OKRs) and SMART goals. Each method focuses on the same thing—setting goals that are specific and measurable, so you have a concrete way to gauge your project’s success. 

For example, imagine you’re working on a project to increase product signups through paid ads. You set a goal to increase signups by 30% over a period of six months. But after that six months is up, signups have only increased by 10%—in fact, the money you’ve spent on ads is more than the revenue you’ve gained through new signups. Since you set a concrete goal, you have compelling evidence to close out your project. Instead of falling for the sunk cost fallacy and continuing to invest in advertising, you can try a new approach. 

Track key performance indicators (KPIs)

A key performance indicator is a quantitative metric you can use to track how a project, team, or organization is performing relative to your goals. Setting KPIs before you begin a project gives you a concrete way to measure success, so you have data in hand when you’re faced with a decision to end or continue your project. That means you can base your decision on the project’s current performance—not how much you’ve invested in the past. For example, you could track customer churn, customer satisfaction, and the total number of paying customers to gauge how a new product is performing. 

Read: Data-driven decision making: A beginner's guide

Create a decision matrix

A decision matrix is a tool that helps you select the best option between different choices. It’s particularly useful when you’re comparing multiple similar choices with several factors influencing your final decision. For example, you could use a decision matrix to determine the best HR management tool for your company—the one you currently use, or two potential alternatives. For each option, you consider three factors: cost, customer service, and customer reviews. You then assign a score for each option based on the rating and weight of each factor. 

In this example, creating a decision matrix helps you weigh the actual costs and benefits of each option—instead of falling for the sunk cost fallacy and just going with the option you’ve already invested time and money in. 

Set a cadence to review your strategy

The sunk cost fallacy can be tricky to detect, especially if you don’t regularly check how your project is performing. That means a failing project can languish for months (or even years) if you never consider whether your approach still works. But when you set up regular progress reports and check-ins to review your project strategy, you’re constantly reminded to reevaluate your project’s success. Each time you check in, you have to decide whether to stop, adjust, or continue with your current approach. 

If you’ve set goals and KPIs for your project, you already have a way to determine whether your current strategy is working. So instead of just setting and forgetting your goals, make a plan to regularly check in and update your progress. Depending on your project timeline, this can be at the end of each week, month, or quarter. 

Using a project management tool can help streamline this process. For example, when you create goals in Asana, you can set a due date and create automated reminders to update your goal progress. Plus, you can easily share progress updates with stakeholders so everyone is informed and on the same page. 

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Don’t stay on a sinking ship

Just because you’ve sunk costs into a project doesn’t mean you have to go down with the ship. With these strategies, you can let go of the past and make decisions based on what’s best for you and your team. The sunk cost fallacy makes you your own worst enemy—but with some self awareness, you can be the key to your team’s success instead.

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