Beware the Dangers of the Sunk Cost Effect
Have you ever stayed in a relationship longer than you should have? Forced yourself to go to an event you were dreading because the tickets had already been paid for? Held onto clothes you don’t wear because they were expensive?
All of these are examples of the “sunk cost effect.” Also known as the sunk cost fallacy, the term describes our tendency to stick something out—even if it is to our own detriment—simply because we have already invested a significant amount of resources into it.
It’s easy to see why this happens. After all, nobody likes to feel like they’ve wasted their time, money, and effort on something. What’s more is that we don’t like to feel like we’ve wasted other people’s time, money, and effort either.
This finding was confirmed in a series of experiments conducted by Christopher Olivola, an assistant professor of marketing at Carnegie Mellon’s Tepper School of Business and author of The Interpersonal Sunk-Cost Effect, a 2018 research paper published in the journal Psychological Science.
In one such experiment, participants were asked to envision feeling full after enjoying only a few bites of cake at a potluck party. Some were told that the cake was expensive and had come from a specialty shop almost an hour away, while others were told the cake had been purchased on sale from a local bakery.
Participants were then given two different scenarios: one in which they had bought the cake themselves and one in which someone else had purchased it. They were then asked whether they’d continue eating it, despite being full. The results of the survey showed that people were far more likely to finish consuming the expensive cake, regardless of who bought it.
In another experiment, participants were asked to pretend they had accidentally booked two non-refundable flights on the same weekend—one to Montreal and one to Cancun—forcing them to choose between the two. When they were informed that one flight cost $800 and the other cost $200, people were much more likely to opt for the pricier trip, even if they liked the cheaper destination better. This held true whether they had paid for the flights themselves or the tickets were gifted to them by a friend.
According to Olivola, there are multiple reasons why people fall into this psychological trap, one of which being that we don’t want to be seen as wasteful (by ourselves or by others). It’s also possible that it’s nothing more than a knee-jerk reaction to regret. Other times, we may carry on with a plan that no longer serves us in an attempt to bridge cognitive dissonance: the mental gap between the price we paid for something and not getting the expected return on investment.
“All of these things are irrational, in the sense that you should realize the money is gone,” Olivola told Time Magazine. “But I do think people do these things because they want to convince themselves that they’ve managed to recapture the loss.”
And it’s not just in our personal lives that we fall victim to this trap either. This flawed way of thinking creeps its way into the business world as well, where it can influence top-level decision making.
“Many managers are susceptible to the famous sunk cost effect, whereby they persist investing in a money-losing project even when it makes sense to invest the new money in alternative new projects,” a behavioral economics article published in Harvard Business Review concludes.
It begs the question: Is there any way to become less susceptible to the effect? The answer is yes. It’s all about being aware and learning when to cut your losses.
“It is a core lesson in many business economics or decision-making classes that any unrecoverable costs sunk in the past are irrelevant when deciding what to do next,” the Harvard Business Review article further states. “Decision-makers need to remember: when sunk costs affect strategic decisions, there can be real and dire consequences.”
According to Matt Remuzzi, CEO of CapForge, there is an easy way to ensure you don’t fall victim to this phenomenon.
“The trick is to ask yourself: If I came to this point today with nothing at risk and nothing spent to date, and had to make a decision, what decision would I make? If the decision you’d make when you pretend you just came to the decision today is different than the decision you were going to make after you thought about all the time and effort and money you’ve already put into something, it’s a good sign you’re about to fall victim to the sunk cost effect.”
If you’re still not sure, try running the question by a friend, mentor, or colleague but without telling them how much you’ve invested already and see if they agree you should keep going or come up with a new plan.
In the end, every decision is a new decision and shouldn’t be weighed down by what you decided in the past. If it doesn’t make sense to continue down a certain path then stop, no matter what came before!