How to avoid the sunk-cost trap?

“When you find yourself in a hole, the best thing you can do is stop digging.”

Warren Buffett

 

What is the sunk-cost trap?

Have you ever found yourself into a situation that you disliked but decided that you have to continue with it because you have been too far? It could be a meal that you ordered and when it is served, you find that it is not what you expected and that you don’t like what is on your plate; but you eat it anyway because it is already served. It could also be a broken relationship with a partner that has significant flaws (violence, alcohol, adultery,…) in which you feel trapped because of the children, house, or other key interests that you have together. In the corporate world, it could be an IT project or a new product launch in which you have made significant investments in time and money without success but that you keep alive with even more investments. These are examples of what psychologists call Sunk-Cost Fallacy or Sunk-Cost Trap.

Sunk cost is a cost that has already been incurred and cannot be recovered. The sunk cost fallacy is the tendency that most of us have to continue an endeavour once an investment in money, effort, or time has been made[1], often even if we would not start the activity had we not already invested in it.

 

 

What explains the sunk cost-trap?

One explanation of our tendency to fall into the sunk-cost trap can be found in the loss aversion theory developed by Nobel Prize winner Daniel Kahneman and his fellow researcher Amos Tversky[2]. According to them, people tend to have a much stronger preference for avoiding losses than for acquiring gains. Losses are twice as powerful, psychologically, as gains. When faced with the decision to stop a failing activity in which we have already made important investment, we tend to assign disproportionate value to past costs versus future costs and benefits. For example, assume that you bought a $150 ticket to attend a concert and that after making further checks about the artist and his work, you realize that you will not enjoy the concert. At that point you could either decide to still go to the concert and not have fun, or you could decide to use that time to do something more enjoyable, which would make more sense. In both case the $150 have already been spent and should therefore not be taken into account when making the decision because it no longer affects the future. However, researchers have found that sunk costs may dissuade most people from choosing the more enjoyable option.

We also fall into the trap of sunk-costs because we have hard time admitting that we made bad decisions. The more a person feels that he or she will be at fault for the loss represented by the sunk costs, the more he or she is likely to fall into this trap. Entrepreneurs are especially exposed to this bias in their decisions making process. The history of business is full of cases where business owners continued to increase their investments into failing businesses even when it was evident that it was not the right thing to do.

 

 

Change your perspective

Holding onto previously invested time, effort, and money because of the sunk-cost trap should not be confused with being persistent which a key quality of successful people. The difference between the two is the perspective that supports the action. In case of sunk-costs trap, past investments are over considered and the decision maker has hard time letting go of the past.

When you are persistent you focus on the future and continuously evaluate your action to ensure that it is aligned with your master intention. Persistence allows you to continue your effort in spite of fatigue or frustration from early failures. One way to clarify the situation is to ask yourself the following question: “If I was starting from scratch today, would I start this same project/activity?” When the answer is consistently no, then you know it is time to quit!

Follow the link below to receive the PDF version of this article including a summary of the three points to remember and that will help you avoid the sunk-cost trap.

 

 

 

References

1.     Arkes & Blumer, 1985, p. 124

2.     Kahneman, D. & Tversky, A. (1984). Choices, Values, and Frames. American Psychologist. 39 (4): 341–350

Other resources

The Hidden Traps in Decision Making, John S. Hammond, Ralph L. Keeney, and Howard Raiffa, Harvard Business Review, January 2006

Written by Maxime Yao

First published 1st July 2018

Copyright 2018 . All Rights Reserved

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