Have you ever ordered an entrée at a restaurant only to realize halfway through the meal that you aren’t hungry anymore? You want to get your money’s worth since you have to pay for the full meal, so you continue to eat even though you’re full.
Congratulations! You just fell victim to the sunk cost fallacy — a form of cognitive bias that affects decisions from the smallest of daily choices to major life decisions. In this article, we dive into the sunk cost fallacy and how it affects different areas of your life. Keep reading for examples of the sunk cost fallacy in everything from business decisions to your love life.
What is the Sunk Cost Fallacy?
The sunk cost fallacy occurs when we place value on something because we’ve already invested time or money in it. Often associated with accounting and financial decision-making, a sunk cost is a cost that has already been incurred and cannot be recovered. These costs shouldn’t be considered when making financial decisions because they’ve already been paid, but when they’re considered, the decision-maker falls victim to the sunk cost fallacy.
The sunk cost fallacy doesn’t just occur in finance. We fall for sunk cost traps in many areas of life, including business decisions, relationships, and even day-to-day activities. Christopher Olivola, assistant professor at Carnegie Mellon’s School of Business and the author of a new paper on the topic, believes we feel the need to “stick to the plan,” even when it no longer serves us, as an attempt to correct cognitive dissonance felt around the original decision. The sunk cost fallacy has also been linked to other theories in behavioral economics, including loss aversion, status quo bias, prospect theory, and self-justification theory, outlined briefly below.
- Loss Aversion Bias: the idea that the pain of losing is twice as powerful as the pleasure of gaining.
- Status Quo Bias: suggests that people prefer things to stay the same by doing nothing or by sticking with a previous decision, even if it no longer serves them.
- Prospect Theory: says that people think in terms of expected utility relative to a reference point rather than absolute outcomes.
- Self-Justification Theory: occurs when a person encounters cognitive dissonance (a phenomenon in which a person’s behavior is inconsistent with their beliefs or desires) and attempts to justify their behavior by denying negative feedback associated with the behavior.
There are those who say the sunk cost fallacy results from our instinctual desire to save face when a decision fails. As decision-makers, we hope to convince ourselves and others that our instincts are right, even if that means digging ourselves into a bigger hole.
The Sunk Cost Fallacy in Business
Consider this quote from Freek Vermeulen, a professor of strategy and entrepreneurship at London Business School: “Once we’ve invested time and money in an idea, future decisions are more influenced by what we’ve already done than by what is in front of us.”
The sunk cost fallacy can be a dangerous trap for business owners, especially when it comes to marketing and advertising decisions. Suppose your company invested in a new marketing campaign that’s been running for four months. The campaign hasn’t met the goals outlined during its proposal and it’s only costing your company to continue. However, your manager wants to continue the campaign because the company has already spent significant money and to scrap the project now would render the campaign meaningless.
In this example, your manager is falling for the sunk cost fallacy. The unsuccessful marketing campaign is a sunk cost your company has already spent money on. To continue the campaign will only result in more loss, while ending the campaign will cut those losses and prevent the company from further expense.
Nokia, the leading phone manufacturing company of the early 2000s, fell into the sunk cost trap when new competitors began revolutionizing the market. Executive leadership continued to pursue funding Nokia’s proprietary (and outdated) operating system, while Apple and Google took over the phone market with new smartphone technology. Nokia couldn’t catch up to its new competitors and lost its place as the top brand in the industry.
Fortunately, there are several ways to avoid the sunk cost fallacy when it comes to your business. Incorporate the strategies below to prevent your business from becoming the next victim of the sunk cost trap.
- Build creative tension across departments in your business. When multiple teams are collaborating on a project, they often have different goals and strategies in mind to complete the task. These competing ideas encourage creative tension, an internal system of checks and balances that can reduce the risk of falling for the sunk cost fallacy.
- Monitor opportunity coststo track alternative courses of action. When you choose a strategy for your business, you inherently forego alternative strategies. Take time to identify these alternative paths before making a decision to confirm that the choice you make is the best for your brand.
The Sunk Cost Fallacy in Money
The sunk cost fallacy could be getting you into trouble when it comes to your finances. Specifically, sunk costs can get in the way of both personal and corporate investments. When it comes to investing, it can be hard to admit you made a bad decision. When a stock loses value and you must consider changing strategies, you may feel as though you failed as an investor. As a result of this cognitive trap, many investors hold on to worthless stocks much longer than they should, losing money and time in the process.
Consider this example. You buy $1,000 worth of stocks in a startup company in January. By December of the same year, the stock value has dropped to $100, even though the overall market and similar stocks have risen in value. Instead of selling your stock and putting the $100 into another stock, you decide to hold onto the stock in the hopes that it rises in value.
The best way to avoid the sunk cost fallacy in investment is to set intermittent goals throughout the lifetime of the investment. For example, try setting a specific return goal for your investment portfolio over the next year. If your portfolio fails to meet this goal, you should reevaluate it to see where you could improve or cut stocks to achieve better returns.
The Sunk Cost Fallacy in Life
The sunk cost fallacy probably sneaks up on you more often than you realize, even in the simplest of daily activities. Here are a few scenarios you’ve probably experienced before.
Example: Concert Tickets
You buy tickets to a concert months in advance. On the day of the concert, you wake up with a terrible cold. You feel awful, but you don’t want to waste the money you spent on the tickets, so you decide to go anyway.
The sunk cost in this example is the money you spent on concert tickets. You can’t get that money back, and by going to the concert with a cold, you’re just making yourself miserable. That’s not getting your money’s worth — that’s you falling into the sunk cost trap.
Your significant other takes you on a date to an upscale restaurant in the city. You both order entrées and enjoy the food, but halfway through your meal, you start to feel full. You don’t want to inconvenience your date by not finishing the food they’re paying for, so you continue to eat even though you’re stuffed.
What’s the sunk cost in this situation? You feel the need to finish your dinner so it doesn’t go to waste, but it’s already a sunk cost for your date. If you don’t clean the plate, your waiter is going to throw it away. The remaining food and the money spent on the order are sunk costs. If you’re full, you only lose by forcing yourself to continue eating.
Unfortunately, the sunk cost fallacy can even apply to your love life (or any type of relationship). Any emotional investment in a relationship can make it harder to leave when things turn sour. The longer you’ve been in a relationship, the harder it feels to break things off. After all, you’ve been through so much together.
The length of time you’re in a relationship is a sunk cost. That time can’t be recovered because it’s in the past. However, by recognizing that prior emotional investment shouldn’t be factored into your present situation, you’re already beginning to pull yourself out of the sunk cost trap.
After high school, your parents encouraged you to pursue a degree in medicine at a prestigious medical school. You were never particularly interested in being a doctor, but you agreed to attend medical school to please your parents. After your first semester, you know medicine isn’t for you. You struggled in your courses and are at the bottom of your class.
Unfortunately, the money you spent on medical school isn’t going back to your bank account. It’s now a sunk cost — you shouldn’t feel obligated to continue pursuing a medical degree just because you’ve already spent time and money to get into medical school. If medical school isn’t for you, cut your losses short and do what you want to do.
Ready to stop allowing sunk costs to dictate the decisions you make in life, love and money? By reading this article, you’ve already taken the first step to beating the sunk cost fallacy. Remember to carefully evaluate several courses of action before making any major decision, especially in business and financial matters.
SalesForce | Bit.AI | Small Biz Genius | Business News Daily | NIHBEST | LifeHack | Schwab IQ | Investopedia | Business Insider | Influence & CO | Corporate Finance Institute | PCC | TIME |SAGE Journals | Science | ResearchGate