The Sunk Cost Effect: Being Trapped by the Past
The Sunk Cost Effect: Being Trapped by the Past
How We Can Steer Clear of Cognitive Pitfalls for Effective Outcomes
Happy Tuesday, Transformation Friends! It's another week and another opportunity to go beyond the status quo.
Today, we’re looking at another cognitive bias that significantly impacts transformation.
Let’s set the stage…
Imagine this: You begin watching a movie, TV series, or reading a book. Partway through, you find it dull, but you persist. The further you progress, the stronger the urge to finish, even though you're genuinely not enjoying it.
This feeling is called the sunk cost effect.
The sunk cost effect is a cognitive bias that compels us to continue an endeavour based on the amount we've already invested—time, money, effort, and emotions—rather than the actual value or outcome we want.
The sunk cost effect can lead organizations to invest more in failing projects, prompt sports teams to keep playing a high-paid but underperforming athlete, or nudge you to overindulge at a buffet wanting to get your money’s worth, even when you’re already full.
You've likely encountered this cognitive bias in your professional life. Today, we'll explore it and learn how to address it effectively.
Grab your morning coffee, and let’s get started.
If you’re interested in other cognitive biases, I've created a collection of the ones we've examined.
What is the Sunk Cost Effect?
Think of the sunk cost effect as the voice in your head that says, "Well, I've come this far; I might as well see it through," even when logic might suggest otherwise.
Arkes & Bulmer (1985) conducted early research on this phenomenon and defined it as such:
The sunk cost effect is manifested in a greater tendency to continue an endeavor once an investment in money, effort, or time has been made.
They highlighted two relevant quotes from the context of public sector investment as examples of this effect:
To terminate a project in which $1.1 billion has been invested represents an unconscionable mishandling of taxpayers’ dollars.
—Senator Denton, November 4, 1981
Completing Tennessee-Tombigbee [Waterway Project] is not a waste of taxpayer dollars. Terminating the project at this late stage of development would, however, represent a serious waste of funds already invested.
—Sanator Sasser, November 4, 1981
Their early research showed that this behaviour is justified by a desire not to appear wasteful. They found that those who had experienced a sunk cost inflated their estimate of how likely a project was to succeed compared to the estimates of the same project by those who had not incurred a sunk cost.
Taking the sunk cost effect a step further, there’s the sunk cost fallacy. This is when we not only factor in those past investments but overvalue them, giving them more weight than they should have in our decision-making process. It's like thinking that the dull TV series you started will somehow get better because you’ve invested time in it (Olivola, C. Y., 2018).
But why do we do this?
Several theories attempt to explain our inclination toward the sunk cost effect.
The saying "throwing good money after bad" describes a basic finding of the sunk cost effect. This behaviour is explained by the Prospect Theory, created by psychologists Daniel Kahneman & Amos Tversky (1979). The theory shows that our decisions aren't always logical. Instead, emotions, past actions, and biases influence us. For instance, the pain of acknowledging a loss or a bad decision often pushes us to invest further in a failing endeavour (loss aversion), hoping for a turnaround. It's a human tendency to want our previous investments, whether time, effort, money, or emotions, to count for something, even if logic suggests otherwise.
Another popular rationale comes from the Cognitive Dissonance Theory. We touched on it in some of the other biases we looked at: we want our beliefs and actions to align. So, if we've invested in something, we try to justify that investment by adjusting the decisions we make accordingly (Arkes & Blumer, 1985).
Another interesting perspective is called "vicarious entrapment." This theory proposes that the previous decisions of others can influence our decisions. For instance, if a colleague initiated a project, we might continue it, not because it's viable, but to justify their initial decision (Olivola, C. Y., 2018).
The sunk cost effect is a powerful cognitive bias that can influence our decisions in ways we might not even realize.
Impacts of the Sunk Cost Effect
The ripple effects of sunk costs
The sunk cost effect can often steer us away from optimal decision-making. Here's how:
It might compel us to stick with projects that no longer promise viable returns, simply because of previous investments.
It can push us towards riskier choices, especially when perceived losses loom large, making us fear the repercussions of abandoning a project (Roth et al., 2015).
Our assessment of potential returns can become overly optimistic, clouding our judgment (Garland, 1990).
We might choose options that aren't truly enjoyable or in line with our preferences, just because they seem to justify prior costs (Olivola, C. Y., 2018).
Staw & Hoang (1995) observed a significant sunk cost effect in the NBA. While teams ideally should prioritize their most effective players, they found that teams disproportionally gave more playing time to players based on their draft status, not their on-court performance. Players drafted early represent a higher cost to the organization in terms of salary (they’re paid more), organizational effort (teams invest more time scouting them), and emotions (marketing potential franchise players to fans).
Factors influencing the sunk cost effect
Garland (1990) found that the more resources already invested in a project, the more likely additional resources would be allocated to it. Intriguingly, the actual incremental costs didn't seem to influence this decision.
Roth et al. (2015) discovered that the sunk cost effect diminishes with time. The longer the gap between the initial investment and the subsequent decision, the less the sunk cost effect influences the choice. Additionally, older adults seem less susceptible to this bias, hinting at a possible age-related resilience.
The social effect
Olivola (2018) expanded our understanding of the sunk cost effect, revealing it's not just an individual phenomenon. People's decisions can be swayed by others' past investments, even if they aren't directly aware of them. This interpersonal effect can be as powerful as individual biases, and interestingly, our relationship with the decision-maker doesn't seem to matter.
Leveraging the suck cost effect to influence behaviour
Thomas (1981) tells an interesting story about Thomas Edison, who turned the sunk costs to his advantage. In the 1880s, Edison was not making much money on his great invention, the electric lamp. The problem was that his manufacturing plant was not operating at full capacity because he could not sell enough lamps. Counterintuitively, Edison increased production. He recognized that most of the manufacturing cost was a sunk cost (he was paying it regardless) and was able to increase production by 25% only adding 2% to the production cost. Edison then sold his surplus in Europe, increasing demand, and the rest is history.
Businesses can strategically employ the sunk cost effect. Customers deeply invested are more likely to engage further (Arkes & Blumer, 1985). Consider subscription models: the upfront commitment often drives users to engage more, even if their interest wanes. As a personal example of this, even though I don’t find much interesting on Netflix anymore, I still find myself scrolling endlessly only to finally capitulate to something I don’t want to watch but do anyway—only me?
Looking at this another way, the sunk cost effect suggests that making an initial commitment, like a gym membership, increases the likelihood of follow-through, whether or not the initial enthusiasm remains. So, if you want to nudge yourself to see something through, make a longer investment (a year-long membership) over well-intentioned shorter ones (four consecutive three-month memberships).
Beyond Humans
Interestingly, this isn't a bias exclusive to humans. Sweis et al., (2018) found the sunk cost effect in mice and rats too. Much like in humans, mice and rats were sensitive to this effect only after an initial investment of time (in this case a foraging task). This finding suggests an evolutionary root for such behaviour.
How We Can Mitigate it
Recognizing the Bias
Awareness is the first step. While understanding the sunk cost effect is essential, Roth et al. (2015) suggest that merely knowing about it isn't enough to prevent its influence. We need to do more.
Tools for Insight
The "SCE-8" scale is a practical tool that gauges vulnerability to the sunk cost effect. By pinpointing these weak spots, we can craft strategies that directly address them (Ronayne, D., Sgroi, D., & Tuckwell, A., 2021).
Objective Decision-Making
Structured Frameworks: Adopt decision-making processes that emphasize present and future outcomes over past commitments. Techniques like cost-benefit and SWOT analyses can help with this.
Focus on what’s ahead: Instead of dwelling on past expenditures, question the path forward: "What's the next step, and what will it bring?"
Establish Clear Boundaries: Set clear criteria for continuation or termination before initiating a project. Reevaluate the project at set points against these criteria.
Limit Investments: Start with smaller investments (pilot projects, prototypes, etc.) and continue with incremental funding. This approach can reduce the potential for large sunk costs.
Valuing External Input
An external perspective can often shed light on blind spots. Engage someone detached from the sunk costs for a clearer viewpoint. And remember, diversity in feedback is key. Multiple opinions can offer a well-rounded view, minimizing potential biases.
Explore Mindfulness
Mindfulness meditation has emerged as a potential counter to the sunk-cost bias. Encouraging present-moment awareness encourages us to detach from the past, focusing instead on the here and now and what lies ahead (Ronayne, D., Sgroi, D., & Tuckwell, A., 2021).
Embracing Acceptance and Adaptability
Reframing the Narrative: Shift your perspective. Instead of seeing halted projects as setbacks, view them as invaluable lessons.
Acknowledging Missteps: It's human to err. Embrace mistakes as growth opportunities and create a culture of psychological safety.
Championing Flexibility: Celebrate the ability to pivot. Highlight the importance of making informed decisions over rigidly adhering to a predetermined path.
Wrap up
As we’ve seen today, the sunk cost effect, this inclination to clutch on past investments of money, time, resources, and emotions, clouds our judgment. It leads us down paths that may not align with our current objectives or desired outcomes. But, as with many challenges, understanding is a good start.
Let’s take a moment to reflect together:
Think about a recent decision you made. Did past investments influence you, or did you evaluate the situation based on its present and future merits?
How might we integrate decision-making frameworks that prioritize current and future benefits, sidestepping the pitfalls of the sunk cost effect?
How might we foster a culture that values adaptability and informed decision-making over unwavering commitment to past choices?
Until next time, stay curious and I’ll see you Beyond the Status Quo.
References
Arkes, H. R., & Blumer, C. (1985). The psychology of sunk cost. Organizational behavior and human decision processes, 35(1), 124-140.
Garland, H. (1990). Throwing good money after bad: The effect of sunk costs on the decision to escalate commitment to an ongoing project. Journal of Applied Psychology, 75(6), 728.
Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision Under Risk, Econometrica, vol. 47, pp 263-291.
Olivola, C. Y. (2018). The interpersonal sunk-cost effect. Psychological science, 29(7), 1072-1083.
Ronayne, D., Sgroi, D., & Tuckwell, A. (2021). Evaluating the sunk cost effect. Journal of Economic Behavior & Organization, 186, 318-327.
Roth, S., Robbert, T., & Straus, L. (2015). On the sunk-cost effect in economic decision-making: a meta-analytic review. Business research, 8, 99-138.
Sweis, B. M., Abram, S. V., Schmidt, B. J., Seeland, K. D., MacDonald III, A. W., Thomas, M. J., & Redish, A. D. (2018). Sensitivity to “sunk costs” in mice, rats, and humans. Science, 361(6398), 178-181.
Staw, B. M., & Hoang, H. (1995). Sunk costs in the NBA: Why draft order affects playing time and survival in professional basketball. Administrative Science Quarterly, 474-494.
Thomas, R. P. (1981). Microeconomic applications: Understanding the American economy.