sunk-cost-fallacy

What Is The Sunk Cost Fallacy? The Sunk Cost Fallacy In A Nutshell

The sunk cost fallacy describes a tendency to follow through on endeavors where time, money, or effort has already been invested. The sunk cost fallacy was first introduced by behavioral scientist Richard Thaler, who suggested in 1980 that “paying for the right to use a good or service will increase the rate at which the good will be utilised.” Psychologists Catherine Blumer and Hal Arkes expanded Thaler’s definition beyond monetary investment, defining the sunk cost fallacy as “a greater tendency to continue an endeavour once an investment in money, effort, or time has been made.

Understanding the sunk cost fallacy

To test the fallacy in a real-world scenario, Blumer and Arkes conducted an experiment.

They decided to sell discounted seasonal tickets at a theatre to determine if the amount of money spent on a ticket influenced the frequency with which people attended. 

In the study, one group of attendees paid the full price of $15. Others were given a $2 discount, with a $7 discount given to a third group. The pair then recorded how many theatre shows each individual attended. They found that individuals who paid full price for their tickets went to 4.11 shows on average.

Those who received a $2 discount went to 3.32 shows, while attendees with the cheapest tickets went to 3.29 shows. Arkes and Blumer had clearly demonstrated the sunk cost fallacy in action.

Attendees who paid full price for their tickets experienced the greatest sunk costs, meaning they were motivated to spend time at the theatre to recoup the higher price of the tickets.

Why does the sunk cost fallacy occur?

The sunk cost fallacy occurs because decision-making is often irrational and based on emotions.

Indeed, failing to follow through on a decision can lead to feelings of guilt, remorse, or shame. 

The fallacy is also related to commitment bias, or a tendency to remain committed to past behaviors despite those behaviors having undesirable outcomes.

commitment-bias
Commitment bias describes the tendency of an individual to remain committed to past behaviors – even if they result in undesirable outcomes. The bias is particularly pronounced when such behaviors are performed publicly. Commitment bias is also known as escalation of commitment.

By failing to understand that the resources expended will never be recovered, the individual makes decisions based on past costs and not on more rational future costs and benefits.

Lastly, sunk cost fallacy may have some relationship with loss aversion.

loss-aversion
Loss aversion is a bias, according to psychologists, where people attribute a stronger psychological weight to losses than to gains. Some psychological studies show that people place more weight on a loss, compared to a gain of the same size. This is labeled loss aversion.

This is a cognitive bias suggesting that the pain of losing something is twice as powerful as the pleasure of gaining something.

As a result, people are more likely to avoid losses than seek out gains. In the context of the sunk cost fallacy, the individual equates a loss with not following through on their decision.

How to avoid the sunk cost fallacy

Making rational decisions by ignoring the investment already made is the best way to avoid the sunk cost fallacy.

This is a simple and effective solution on paper, but even the most logical people can be influenced by the fallacy when encountering it in real-world scenarios.

Research has also shown that simply knowing about the fallacy is not enough to avoid its influence. With that said, here are a few ways to avoid the psychological trap of sunk costs:

Omit the past in decision-making

Decisions should be based on future costs and benefits by looking forward. Resist the urge to consider the cost of past actions in the decision-making process.

In business, will pivoting on a project increase customer satisfaction scores?

Will a move to the cloud enable the organization to scale and meet higher-level goals? 

Reframe past costs

Instead of considering past costs as a loss, think of them as costs that got the business to where it is today.

A new tool that didn’t quite meet expectations could be reframed as a tool that supported the team until something better could be developed.

A previous relationship that ended badly could be reframed as an important learning opportunity.

This process is known as cognitive reframing, a psychological concept that may help the individual avoid making illogical decisions.

Use technology in decision-making

Wherever possible, technology should be used to make decisions because it will not be swayed by the psychological satisfaction of sticking with sunk costs.

For businesses, machine learning and predictive analytics encourage leadership to make forward-thinking decisions. 

Key takeaways

  • The sunk cost fallacy describes a tendency to follow through on endeavors where time, money, or effort has already been invested. It was first introduced by behavioral scientist Richard Thaler in 1980.
  • The sunk cost fallacy occurs because decision-making is often irrational and based on emotions. It is also closely associated with commitment bias and loss aversion, with the latter describing a tendency for individuals to avoid losses rather than pursue gains.
  • The sunk cost fallacy can be difficult to avoid for even the most logical thinkers. Cognitive reframing and the use of technology in decision-making are two strategies individuals and businesses can use to avoid it.

Connected Business Concepts

First-Principles Thinking

first-principles-thinking
First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.

Ladder Of Inference

ladder-of-inference
The ladder of inference is a conscious or subconscious thinking process where an individual moves from a fact to a decision or action. The ladder of inference was created by academic Chris Argyris to illustrate how people form and then use mental models to make decisions.

Six Thinking Hats Model

six-thinking-hats-model
The Six Thinking Hats model was created by psychologist Edward de Bono in 1986, who noted that personality type was a key driver of how people approached problem-solving. For example, optimists view situations differently from pessimists. Analytical individuals may generate ideas that a more emotional person would not, and vice versa.

Second-Order Thinking

second-order-thinking
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and eventuality. It also discourages the tendency for individuals to default to the most obvious choice.

Lateral Thinking

lateral-thinking
Lateral thinking is a business strategy that involves approaching a problem from a different direction. The strategy attempts to remove traditionally formulaic and routine approaches to problem-solving by advocating creative thinking, therefore finding unconventional ways to solve a known problem. This sort of non-linear approach to problem-solving, can at times, create a big impact.

Moonshot Thinking

moonshot-thinking
Moonshot thinking is an approach to innovation, and it can be applied to business or any other discipline where you target at least 10X goals. That shifts the mindset, and it empowers a team of people to look for unconventional solutions, thus starting from first principles, by leveraging on fast-paced experimentation.

Biases

biases
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman in 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.

Bounded Rationality

bounded-rationality
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.

Dunning-Kruger Effect

dunning-kruger-effect
The Dunning-Kruger effect describes a cognitive bias where people with low ability in a task overestimate their ability to perform that task well. Consumers or businesses that do not possess the requisite knowledge make bad decisions. What’s more, knowledge gaps prevent the person or business from seeing their mistakes.

Occam’s Razor

occams-razor
Occam’s Razor states that one should not increase (beyond reason) the number of entities required to explain anything. All things being equal, the simplest solution is often the best one. The principle is attributed to 14th-century English theologian William of Ockham.

Mandela Effect

mandela-effect
The Mandela effect is a phenomenon where a large group of people remembers an event differently from how it occurred. The Mandela effect was first described in relation to Fiona Broome, who believed that former South African President Nelson Mandela died in prison during the 1980s. While Mandela was released from prison in 1990 and died 23 years later, Broome remembered news coverage of his death in prison and even a speech from his widow. Of course, neither event occurred in reality. But Broome was later to discover that she was not the only one with the same recollection of events.

Crowding-Out Effect

crowding-out-effect
The crowding-out effect occurs when public sector spending reduces spending in the private sector.

Bandwagon Effect

bandwagon-effect
The bandwagon effect tells us that the more a belief or idea has been adopted by more people within a group, the more the individual adoption of that idea might increase within the same group. This is the psychological effect that leads to herd mentality. What is marketing can be associated with social proof.

Read Next: BiasesBounded RationalityMandela EffectDunning-Kruger EffectLindy EffectCrowding Out EffectBandwagon Effect.

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