Sunk Cost and the Sunk Cost Fallacy

Individuals commit the sunk cost fallacy when they continue a behaviour or endeavour as a result of previously invested resources (time, money or effort). This fallacy, which is related to loss aversion and status quo bias, can also be viewed as bias resulting from an ongoing commitment.

For example, individuals sometimes order too much food and then over-eat just to “get their money’s worth”. Similarly, a person may have a $20 ticket to a concert and then drive for hours through a blizzard, just because she feels that she has to attend due to having made the initial investment. If the costs outweigh the benefits, the extra costs incurred (inconvenience, time or even money) are held in a different mental account than the one associated with the ticket transaction.

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Sunk Cost and the Sunk Cost Fallacy

Here’s the video link of the transcript below: https://www.youtube.com/watch?v=pgc5nk6Dsaw

{Transcript}

Have you ever gone to a grocery store, gone to checkout, stood in a line, and then noticed that the line next to you is moving faster than the line you’re in? When you chose the line, your line was the shortest, but now the other line is moving faster and has caught up to you. So what do you do—do you change lines?

I’m Jason Stead, an instructor with Stitt Feld Handy, and I’m going to talk to you about a way to approach decision-making that will impact a number of different decisions you make. It will hopefully impact your negotiations, your dealings with difficult people, and a lot of different problems that you encounter on a day-to-day basis. This is going to reflect the bigger-picture decision-making process and hopefully help you think about some ideas on how to make those decisions.

I’m going to talk to you about sunk costs and the sunk cost fallacy. I want to talk about the process that goes into the decision about whether to switch lines at a grocery store. Then I’m also going to talk a bit about how that expands to bigger decisions, like making decisions about when to hire or fire a new employee.

A sunk cost is a cost that you have already incurred and is not recoverable. It’s often money, but it can also be something like time or effort. An example of money would be money that you’ve spent on a movie ticket or a parking pass. It can be effort you’ve spent on a group project, or time you’ve spent planning a trip. The key to it being a sunk cost is that there’s nothing you can do to get it back.

I want to talk about sunk costs and how it ties into a more commonly used phrase and a more common problem that we run into—and that is the sunk cost fallacy. The sunk cost fallacy is the idea that we are more likely to continue with something that we have already sunk a cost into, even if it does not make as much sense going forward. As people, we incorrectly attribute too much value to something just because we’ve already sunk a cost into it.

Let’s say you bought tickets for a movie and the tickets were fifteen dollars. When you’re about to go into the theater, someone offers to give you tickets to a movie you’d prefer to see—for free. The only caveat is that you’d have to throw away the tickets you just spent fifteen dollars on. So what would you do? Are you going to take the tickets to the movie you’d prefer to see, or the movie you don’t like as much?

The fact that you’ve spent the fifteen dollars on the movie tickets should be irrelevant to your decision going forward. But there’s something holding you back—it feels like it would be a waste of the fifteen dollars if you just threw out those tickets. In real life, people tend to decline the tickets to the movie they prefer to see, even though the cost for both is the same. The fifteen dollars is gone; you’re not going to get that money back. In those situations, we should be making our best decision for us going forward—but we’re not. And by not making the best decision, we’re committing the sunk cost fallacy.

When you’re making decisions, I want you to think about: what’s the best decision for me going forward? Rather than thinking about the various costs—time, effort, energy, money—that you’ve already spent. When we’re falling into the sunk cost fallacy, we’re overvaluing the time or money that we’ve put into something, and we feel like, “Oh, it’ll be a waste if I don’t go to that movie that I spent fifteen dollars on.” Well, I can tell you—it’s a waste either way. That money’s already spent. It’s already gone. That should be considered irrelevant to the decision that you make for yourself going forward. Make the best decision for you.

It’s one thing to understand this when buying movie tickets, but I want to talk a bit about how it applies to real life. Let’s go back to the grocery store example from earlier. You’ve been waiting in your line for three minutes and it’s barely moved at all. The line next to you used to be a lot longer, but now it’s caught up and is the same length—and it’s clearly moving faster than your current line.

You need to decide if it makes sense for you to switch lines. What’s holding you back from changing lines? If you were approaching the lines now and you knew one was moving faster, and they were both the same length, it would be an obvious decision—you’d go in the faster line because your goal is to get to the cashier and get out of the grocery store as soon as possible. So this should be an easy decision.

But we don’t switch. What’s holding us back? It’s that we feel like we’ve spent three minutes waiting in this line. Those three minutes could have been spent doing something else—you could’ve been shopping, talking to someone, checking email. Instead, you’ve been waiting in line. And if now you switch lines, that entire three minutes already spent feels wasted.

Well, I’m going to go back and explain the sunk cost fallacy—because that three minutes is already wasted. It’s a sunk cost. That time is gone, and there’s nothing you can do to get it back. Can you see how this falls into the sunk cost fallacy?

When thinking about decisions, we want to keep our ultimate end goal in mind: what do we want to get out of the scenario? In this case, we want to get out of the grocery store as soon as possible and make the decision that will get us there the best way.

It’s one thing to think about the sunk cost fallacy in grocery lines—but there are much larger, real-world implications. Let’s say you’re hiring a new employee. You’ve interviewed several candidates and chosen one you believe will be the best. The employee starts the job and spends six months getting up to speed. After a year, you realize that the employee isn’t what you expected. You’re pretty confident that one of the other candidates would do a better job.

You’ve invested a year into this employee and paid them for that year without getting much value. Now they’re up to speed, but doing the job poorly. If you let the employee go, you’ll have to restart the hiring process and incur those costs. What you don’t want to do is fall into the sunk cost fallacy.

Let’s think about which costs are already sunk: the salary paid over the year—that’s sunk; the time spent training them—also sunk; the effort in hiring them—gone. These are unrecoverable.

So what should you think about? What makes the most sense going forward. You want to do a cost-benefit analysis to determine what’s best. Keeping the current employee means no new hiring or training costs. Hiring someone new means someone who can likely do a better job. When framed like this, the decision becomes clearer.

Think: what better meets my needs as a company? Generally, going through the hiring process again is the better option—because you want good employees, and you want to be successful.

If we can stay focused on future decisions rather than past costs, we’ll be better decision-makers moving forward.

Avoiding the Fallacy

So what can you do in your life to avoid falling into the sunk cost fallacy?

First, be aware of it. Think about why you’re making a decision. Ask: what’s the best decision for me going forward—regardless of what’s been spent?

A good trick is to practice with small decisions. Let’s say you go out to eat, park your car, and pay for parking. Then you walk to the restaurant and discover it’s closed. Now you need to decide what to do. Do you go to a nearby restaurant, even if the food isn’t great, just to justify the parking? Or do you leave and drive to another restaurant where you actually enjoy the food?

Well, you want to think about your goal. Your goal in this case is not spending too much money and having a good meal. Which of these decisions is better to meet your goals? What’s important to you?

What I would encourage you to do is not fall into the sunk cost fallacy—not think about the fact that you’ve already spent the money on parking. Because no matter which decision you make, that money you’ve spent on parking is not going to be recoverable. It’s gone.

If you’re trying to avoid falling into the sunk cost fallacy, it can be easy to do this by looking at small everyday decisions like this: “Which restaurant am I going to go to?” and thinking about, “How much have I sunk into this?” and “Am I considering what I’ve sunk in when making my decision going forward?”

Another quick example as I’m wrapping up: you’ve now spent a number of minutes watching this video on the sunk cost fallacy. There’s nothing you can do to get that time back, but you want to make the best decisions for yourself going forward. So I’d encourage you to take some lessons away from this video. And remember—think about what you want out of a scenario, and don’t get caught up in what you’ve sunk in that you’re never going to get back.