Ever came across a situation where you knew there’s no future but still you kept putting in your time and efforts? Sounds so foolish! But more often than not we all have committed this error in judgement, simply because we felt it was too late to redo the decision! All credit behind this goes to a full fledged theory that’s very common especially in the business world and psychology too, it’s called sunk cost fallacy. When I first read about it in one of the business blogs, I was quite amazed. The raw practical application of this theory made me wonder so much goes around us and we often don’t link it with what we studied in books! Hope you enjoy reading my version of everything related to sunk cost fallacy!
What is Sunk Cost Fallacy?
Leaving away all technical terminologies, sunk cost fallacy takes place when you still continue with a decision only because you don’t want your investment to go to waste. Even when you know discontinuing is for your best as the decision you took earlier is not profitable at all, still you keep investing. There can be many reasons behind still continuing with the decision like being too emotionally invested, being optimistic etc.. While this investment can be in terms of money, time or even emotions! In short, the current cost outweighs the benefits but you still keep investing.
Example time, imagine you went to watch a movie but after 15 minutes you realised that you are getting thoroughly bored. Still you decide to sit through the remaining two hours and 15 minutes only because you don’t want the ticket money to go to waste! This is a sunk cost fallacy because if you had instead spent that time doing something you liked or doing something productive, you would have made better use of opportunity cost of time.
G.K. Fact: The term sunk cost fallacy was first introduced by Richard Thaler, a behavioural economist.
P.S.: Came across too many similar terms? Sunk cost fallacy is also known as concorde fallacy!
Sunk Cost Fallacy Applies to Business Too
The first thing that came to my mind was why would anyone take a decision that would lead to a loss? Like, anyone runs a business or takes a business decision only to make profits right? But this theory actually applies to a lot of things in business.
For example, you invested Rs. 100,000 for opening a new wing in your business. After a while you realize that this business decision will not work, but to keep the new wing afloat, you keep on investing even more money like rent, wages etc. These costs once paid can’t be recovered, i.e. they are sunk costs. Still you keep on investing only because you don’t want the initial capital to go to waste, a prime example of sunk cost fallacy. Economists call it throwing good money after bad.
Same thing applies to a business idea, when you still continue with a business idea even after knowing it’s not profitable only because you invested a lot of time and resources into it, you fall into a sunk cost trap. It’s a decision making error which you hesitate to correct.
Actually many types of sunk cost fallacy in business exists which are really interesting, you can enjoy reading all about it in my dedicated blog for the same!
Relationships and Sunk Cost Fallacy? What’s That?
‘This relationship is sucking your energy, let it go…”
“But I invested so much time and effort into it, I can’t…”
Ever faced this dilemma? You are actually stuck in a sunk cost fallacy! ‘Toxic relationships’ and the hesitancy to come out of them is the biggest example of sunk cost fallacy in relationships. One feels that they have invested so much time and emotion into a relationship that they can’t afford to lose it. This is when in their subconscious mind they are well aware that this relationship will never work, rather it will drain them.
Being committed in a relationship is important but not when you know it’s only draining you emotionally and there is no future in the relationship. It’s high time that the popular Bollywood movie dialogue, “Ek baar jo maine commitment kar di, toh main apne aap ki bhi nahi sunta”, meaning once I make a commitment I don’t even listen to myself, needs to be matched with being rational! Phew! Who knew an economics theory applies to real life relationship situations too?
Why Do We Get Stuck in Sunk Cost Fallacy?
All of us are smart, still sometimes we get stuck with sunk cost fallacy, ever wondered why? There are multiple reasons, here you go.
1. Being Too Optimistic
Whether it’s a sour relation or a bad business decision you keep telling yourself, it will get better! This is general human behaviour. This might lead you to keep sticking to your relationship or decision even when you know it’s doomed.
2. Tendency to Avoid Wastage
We don’t like wastage! That’s one of the biggest reasons one gets stuck with wrong decisions! Even when we know letting go is the best decision still we keep sticking to it because we can’t let the previous investment in terms of emotions, time or money go to waste! Though finally it leads to even more wastage.
3. Being Stuck on Past Investments
You already made investments in the past and now you just feel like you can’t stop! In short, your decision making capabilities go for a toss as you think only about the past and start avoiding thinking about future well being.
4. Ego and Uncertainty
No one likes to accept failure. The easiest way out is to keep justifying that your decision was somehow correct! The ego doesn’t let one think rationally and the fear of uncertainty just cements it.
5. Being Over Committed
We often get attached to things, decisions and relationships. This hesitancy to abandon, further leads to a cognitive bias and makes it difficult to make correct decisions.
6. Not Recognising Diminishing Returns
Even after getting diminishing returns on your investment, you still keep on investing in the incorrect decision, only because so much is already invested. This fear of letting the prior investment go waste makes you immune to even diminishing returns.
How to Avoid The Sunk Cost Trap?
Not an easy thing to do, but if you are determined nothing can stop you from taking the decisions that benefit you the most.
1. Recognise ‘Want’ or ‘Need’
If your incorrect decision is a want not a need, you can let it go. The most common rollercoaster example fits here. If you are standing in a line for a rollercoaster ride since one hour and it will still take a lot of time before your turn comes, you can leave the line and instead go to enjoy other carnival rides or games. The rollercoaster ride was your want and not a need, so you can put your rest of the time in the carnival to better use.
2. Understanding Time is Money
Applying especially to business decisions, you need to recognise you can’t dedicate your precious time to something more productive and profitable IF you keep sticking to things that are only sucking your time while their future probability of getting results is negligible.
3. Being Receptive to Change
Falling into the uncertainty trap is common but once you become adaptable, you will notice that your decision making capabilities improve and you avoid falling into the sunk cost fallacy too.
4. Focusing on Future Potential Benefits
Taking rational decisions and prioritising rationality over emotional or monetary investment is essential. Think how much benefit you can gain in the future. Be rational and focus on the costs and benefits of your present actions.
5. Avoiding Influence of Potential Loss
Rather than thinking about the loss you will face if you discontinue with your decision, you can focus on reallocating resources to reduce the loss. This especially applies to a business decision like reallocating resources of the current project that has no future to a new project.
6. Setting Clear Goals
When you know what to achieve and what are your priorities, you can make rational decisions that will actually benefit you.
7. Plan ‘B’ Can Help
Sometimes you don’t need to let go of a decision altogether, rather you can alter it to increase the chances of its success. You just need to evaluate carefully.
8. Reach Out to an Unbiased Person
Be it a business expert if it’s a business decision or a counselor or friend if it’s about real life decisions or relationships. When you feel you are stuck in a sunk cost fallacy, reach out to a person who can give their unbiased opinion to you. The final decision is yours but you get to know a different perspective as well.
Sunk cost fallacy is basically a decision making pitfall in both real life and business. Time to recognise and avoid it! My version of this whole theory is more about the practical application and how I felt that we can manoeuvre away from falling in this sunk trap. I hope you enjoyed reading it! Would love to know your views on this amazing theory as well!