You are at a nice restaurant and you realize you aren’t as hungry as you thought, feeling full after eating only half of your expensive entrée. A take-home box isn’t an option because you aren’t going home afterwards, so you finish the meal because you paid a lot of money for it and don’t want to be wasteful.
Then you spend the next hour in misery, wishing you hadn’t eaten so much.
You are the victim of the sunk cost fallacy.
Most people are familiar with the concept. It’s straight out of “econ 101” yet continues to be one of the costliest mistakes people and businesses make.
Past and future costs
Here’s how it works:
Step 1: You buy or invest in something of value.
Step 2: At some point in the future, the value of the purchase decreases or the cost increases, creating a negative return on your investment
Step 3: You decide to continue to incur the costs, even though it is no longer worth it.
For example, let’s say you buy a concert ticket for $100. The evening of the concert, a snowstorm comes through making it difficult and dangerous to attend. There are now the additional costs of time and peril. Should you still go to the show?
You feel that you need to go because you paid 100 bucks and want your money's worth. But if you consider that on the day of the concert the money is gone whether you go or not (a sunk cost), it may be a bad bet.
The question should be – at this point, do the costs you will now incur of danger, discomfort, and potential hours in traffic outweigh the amount of enjoyment you would get, regardless of the initial outlay?
If you had paid nothing for the ticket, would you brave the elements to go? If the answer is no, it should also be no even if you had spent $100.
Good money after bad
The sunk cost fallacy is often counter-intuitive and can be tough to swallow, especially if the initial cost was large.
In my days as a systems developer, I once worked on a project where the business environment and user needs had shifted so that the value of the project fell below the future costs of continuing with the project, creating a negative ROI.
At that point, the project should have been halted. But as is often the case in the corporate world, the project was continued anyway, incurring costs that outweighed the benefit.
Why are projects continued when they cost more than they are worth?
When a manager green lights a project, it is a reflection of the manager’s decision making skills. If the project is later scrapped, it would feel like the original decision was a bad one - a waste of money. Their reputation would take a hit.
However, in many cases it wasn't actually a bad decision. In the current fast moving business environment, unforeseen forces change the value or future cost of a given project. Starting the project may have been a great decision, but continuing with it is not.
Yet the manager feels that it would be better to try to salvage some value out of the project since so much money was spent at the outset.
That’s a mistake that can be costlier than the original investment, causing even more waste.
Recognition and prevention
So how can we overcome the invisible mind block of the sunk cost fallacy?
1) After an initial cost is incurred, commit yourself to being flexible and honest in your future assessments of value vs. cost. Force yourself to disregard sunk costs when determining whether the projected value is greater than the future costs.
2) Even if the original decision to make the expenditure was a bad decision, when it becomes obvious, admit the mistake and cut your losses. It stings but is the better option.
By making rational assessments at intervals after the sunk cost is incurred, you can save yourself or your organization resources that could be put to more profitable uses.
Think well, be well!
- Steve Haffner
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