How often has this happened to you? You’ve started getting the feeling that one of your projects is a bad use of your time. But the company has already invested so much money, or so much time, that giving up on the project would be admitting that it was all a waste. Plus, if you’re the one who made the decision to invest, chances are that you’d be the one blamed. Congratulations. You’re a victim of the sunk cost fallacy.
The problem with falling for the sunk cost fallacy is that, whatever you decide, it’s not like you can get the money back, writes Michael Davidson in Lifehack. “In economics, a sunk cost is any past cost that has already been paid and cannot be recovered,” he writes. “For example, a business may have invested a million dollars into new hardware. This money is now gone and cannot be recovered, so it shouldn’t figure into the business’s decision making process.”
A particular example of the sunk cost concept is that of the dollar-bill auction. Someone offers a $1 bill (sometimes a $20 bill) up for auction, with the rule that whoever comes in second also has to pay the amount they bid. People continue bidding for the bill long past the point where they would make money, or even break even, on the deal, simply because they don’t want to lose money by coming in second and getting nothing.
In business, the dollar bill auction is usually represented by continuing to invest money in a project past the point that it will offer any returns. “Dollar Auction is about over-involvement, how just getting started can sometimes lead to getting more and more and more involved,” writes J. Keith Murnighan in Bargaining Games. “Private-sector organizations suffer from the same problem. Many computer firms, for instance, have found that they get enmeshed in deciding whether to invest in a new product and, by the time it has been designed and produced, another firm has beaten them to the market with a product that’s more advanced than theirs.”
Both the sunk cost fallacy and the dollar-bill auction are examples of cognitive bias, or ways in which your thinking is flawed. The field of behavioral economics studies such fallacies, in the hopes that you can be more aware of them—or, at least, that you can use them to help take advantage of other people.
It all comes down to human nature—both are related to the tendency people have for loss aversion. People typically would rather avoid losses than get gains, even if the gains are bigger, writes David McRaney in You Are Not So Smart. Moreover, according to behavioral economist Dan Ariely, this is particularly a factor when it comes to anything that’s free.
“When anything is offered free of charge, Ariely believes your loss aversion system remains inactive,” McRaney writes. “Without it, you don’t weigh the pros and cons with as much attention to detail as you would if you had to factor in potential losses.” How often have you had to try to convince someone that, even though a particular software package was free, it could end up costing the company more in the long run?
Moreover, honoring the sunk cost means you aren’t just out the initial investment, but the opportunity cost of missing out on what you could be doing instead, writes Robert Leahy in Psychology Today. “Are you sacrificing other opportunities because you are stuck with the sunk cost?” he writes, such as giving up the possibility of other projects by sticking with this one that is leading nowhere. “What is the opportunity cost of your commitment to a past decision?”
Think that because you’re a rational, intelligent computer person that you’re not susceptible to this? Think again. How much time are you still investing in playing Pokemon Go just so that you can maintain your position? “Your neglect has consequences,” McRaney writes (though the example he was using was Farmville). “If you don’t return, your investments die and you will feel like you wasted your time, money and effort. You must return, sometimes days later, to reap the reward of the time and virtual money you are spending now. If you don’t, not only do you not get rewarded, you lose your investments.”
How do we break the cycle of the sunk cost fallacy? “We fall victim to the sunk cost fallacy because we are emotionally invested in whatever money, time, or any other resource we have committed in the past,” Davidson writes. If you’re having trouble with this about a particular decision, he advises making a list of pros and cons. “If the only pro of continuing to do something is to feel better about the emotional investment you’ve made, clearly you should go in the other direction.”
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