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May 11, 2022 Category: Information System (5 minutes read)

The Sunk Cost Fallacy – Stay the Course or Quit?

The Sunk Cost Fallacy – Stay the Course or Quit?

The sunk costs fallacy refers to our tendency not to continue with an endeavour if we have already put time, effort or money into it. Sunk costs, in economic terms, are the costs that we have already incurred and cannot recover. Sunk costs can be seen in significant life decisions, such as staying in a costly graduate program to get paid for the first year. But it also shows up in small daily decisions like continuing to watch a movie until the end, even though it's boring and not enjoyable. The sunk cost fallacy is often described as individuals choosing career paths that are not the best fit despite the new data.

 

Many trainees fall for the sunk-cost fallacy. Many postbacks will tell you, "I was a pre-med major, so I must go to medical school." However, many graduate students and postdocs also say, "I have been researching this topic for five years. I cannot stop because I have put so much effort into this work."

 

These are just a few examples of sunk expense. These sunk costs often occur because humans are not rational decision-makers. Our emotions and our commitment biases can often influence our decisions. For example, we may continue to support past decisions and recommit even when new evidence suggests this is not the best way to proceed. Many people fall prey to this decision fallacy, where they base their decisions on the past and not future or present benefits and costs. This method of decision making can often lead to suboptimal outcomes.

 

This could be due to loss aversion. Losses feel worse than gains. Therefore, people will be more inclined to seek out losses than avoid them. Unfortunately, the sunk cost fallacy can lead to a vicious cycle. You will feel more pain if you don't make a decision and leave.

 

It is impossible to avoid the sunk costs fallacy in making decisions. However, it can be helpful to recognize its power within one's thinking process. You can cut down on your sunk costs and leave if you decide that a career path is not suitable. You can make a new decision based upon new data or personal evidence.

Managers are often susceptible to the infamous sunk cost effect. This is when they continue to invest in projects that are losing money, even though it makes more sense to use the money to fund other projects. This article provides managers with a research-based way to assess their susceptibility. For example, are you still involved in a project even though you should have stopped? You persevered in a relationship even when there was no way out? You dragged yourself to an event in poor weather because you had already purchased the ticket with your hard-earned money. These are examples of the sunk-cost effect when someone decides to continue doing something because they have previously invested (unrecoverable) resources.


This is often due to well-known, high-stakes decisions made in various contexts. For example, the decline of General Motors in the latter part of the 20th century is attributed to its refusal to abandon once-winning strategies. The British and French governments made considerable investments in Concorde's project, even though they threw good money after bad. This is sometimes called the Concorde fallacy. In the political realm, the long-running U.S. military operations in Vietnam and Iraq show that this effect can cause financial ruin and the loss of thousands of lives.

Many business economics classes or decision-making classes teach that unrecoverable past costs are irrelevant when deciding what next. Sunk costs can have dire consequences for strategic decisions. Decision-makers must remember this.



Assessing your team's vulnerability to the sunk-cost effect

Researchers tackle the problem of measuring the effect by asking people questions about their responses to hypothetical scenarios. The scenarios don't usually cover all costs (e.g. money, time and emotion). We don't know if the hypothetical scenarios can predict whether people will succumb in real-life situations.

The "Evaluating Sunk Cost Effect" is a recent work that bridges these gaps. This new scale includes eight questions to determine susceptibility to this effect. Each scenario is a real-life example of an everyday situation that everyone should be able to see themselves in. The methods can be combined to cover a wide range of costs. Because people's resources are often highly interconnected, there is a wide range of prices that 1can be sunk. Many important decisions, for example, require more tangible and quantifiable costs like time and money. However, people may also feel more personal expenses, such as emotion and effort, so that each person might feel the burden of these costs differently. It is not a good idea to limit the types of resources available in a scenario to one or two. It is better to include methods that highlight different types of resources.



How did we do it?


An initial set of 18 scenario-based questions were asked to participants. They covered five resources people use (effort, money, emotion and belief). The questions were drawn from various sources. Here's an example of one scenario which emphasizes action but also time (the relevant text has been underlined for illustration purposes).

You've been anticipating this year's Halloween party. Finally, you have the perfect cape, wig and hat. You have spent all week trying to perfect your outfit. To glue the cape and hat together, you will need to cut many tiny stars. You decide that your Halloween outfit is better without all the leads you worked so hard to make.



Which point of the scale below best describes your idea?


Wear stars o o o o o o Go without

The statistical analysis of the response data showed that eight of those 18 were selected, leaving us with the scale "SCE-8". The exhibit Testing Sunk costs offers the resources that each scenario focuses on. Our analysis revealed which methods best described the variation in the data. Surprisingly, all eight procedures we have left cover the entire range of resources. This supports considering many resources when determining susceptibility to the sunk cost effect.

Each question generates a score from 0-to 5. 0 is the lowest susceptibility, and five is the highest. The scores from each question are then added together to create a susceptibility score of 0-40. Our data showed a lot of variation between susceptibility scores (including 0 and 40), but the average score was just under 10.

 

Sources:

https://oitecareersblog.od.nih.gov/2021/11/22/sunk-cost-fallacy-how-it-affects-career-decision-making/

https://hbr.org/2021/07/how-susceptible-are-you-to-the-sunk-cost-fallacy