What is the sunk cost fallacy and how to avoid it in 7 easy steps

In 1965, the construction of a supersonic Concorde jet started, which was the subject of the contract between the British and French governments. At the very design stage, it was assumed that the investment wouldn’t be profitable (due to the high costs of production and the unprofitability of flying with rising oil prices). The final value of producing this aircraft was 10 times more than it had been expected, and that’s why only 20 jets were built. The planes were used for 30 years but kept generating losses until they were finally discontinued at the end of 2003. The Concorde project is a perfect example of the phenomenon known as the sunk cost fallacy. In today’s post, we will explain this cognitive error and how it can affect the decisions you make. Read on.

What is the sunk cost fallacy?

The sunk cost fallacy, also known as the Concorde effect, is a cognitive error that is about making decisions based on money, resources, or effort already invested in a given project, instead of rationally assessing the future benefits. In practice, this means that people are afraid of losing what they’ve already invested, and continue erroneous actions (often subconsciously) even though all the evidence suggests that further investments are simply unprofitable. In this respect, Richard Thaler, an American economist, formulated three hypotheses:

1. the more costs incurred, the more effort you make to save the project,
2. suspending the project is less painful than resigning from it whatsoever,
3. over time, the project is finally depreciated or canceled, regardless of the invested money.

Examples of the sunk cost fallacy

The sunk cost fallacy can be noticed in various aspects of everyday life – both personal and professional. Let’s take a closer look at some examples:

• Business – a company that has already invested a lot of money and time in a particular project that doesn’t bring the expected results, may continue to work on it despite a lack of real prospects of its success (not to ‘lose’ the money that has been already invested).
• Education – a person who spent many years getting an education in the chosen field may be willing to continue working in a position that doesn’t bring them any satisfaction (simply because they have already spent a lot of time and other resources on learning),
• Personal relationships – people may stay in toxic or unsupportive relationships as they fear ‘losing’ time spent with a particular person.
• Financial investments – investors may continue to invest their resources in slipping stocks or unprofitable projects as they have previously invested a lot of money in them, and they don’t want to waste it.
• Politics – policymakers may continue to implement projects that don’t deliver the expected results just because significant public funds have been already spent on them.

Why is the sunk cost fallacy harmful?

Sticking to unprofitable projects simply because we have already invested our resources in them may lead to greater time and financial losses. However, these are not the only consequences that are associated with this cognitive error.

Such decisions are based on irrational convictions rather than on actual data, facts, and analyses, and make us feel uncomfortable, frustrated, and stressed. When it comes to business, the sunk cost fallacy may block new opportunities, which can sometimes lead to decision-making mistakes.

How do we avoid the sunk cost fallacy?

Although the sunk cost fallacy is a subconscious feeling, it’s possible to combat it. However, it’s necessary to take a realistic approach to decision-making. You may, for example:

• conduct a rational analysis of the benefits and invested resources,
• define goals accurately,
• allocate resources thoughtfully,
• accept the incurred losses,
• ask your coworkers, mentors, and experts for feedback to help you remain objective,
• continuously search for alternative solutions,
• prepare a contingency plan in case of failure, which will help you make a decision to cancel a project and keep calm.

Combat the sunk cost fallacy with Firmbee

Using Firmbee at work, you can minimize the risk of falling into the sunk cost trap at the very planning phase. Start with setting your project’s budget, estimate the time you will need to finish it and impose its deadline.

In Firmbee, you can also use the check-in feature, thanks to which you can ask repetitive questions to your team, for example, about their work progress. With check-ins, you no longer have to send updates manually – just decide when and how often they should be delivered to your teammates.

You can also avoid the sunk cost fallacy by being up-to-date with your team’s work. A transparent Kanban board, whose sections and statuses can be adapted to your working style, will make it a lot easier. What’s more, you can share the Kanban board with external individuals, which will let you get their feedback.

Summary

We strive to be cost-effective both in our personal and professional lives. That’s why we need to be aware that our decisions can sometimes be influenced by the sunk cost fallacy. We should try to mitigate this effect by taking alternative options, asking critical questions, conducting rational analyses, and getting external opinions.

We can achieve better results, in line with our expectations and goals, by making conscious decisions and walking away from unprofitable investments. However, this will undoubtedly require a great deal of courage and the ability to keep our emotions in check, which we should constantly work on.

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