Business Blind Spots | Sunk Cost Fallacy
Jeff Toth, Marketing & Communications Specialist, IBAO
You got to know when to hold ’em Know when to fold ’em Know when to walk away And know when to run.
- Kenny Rogers
With HMV, it’s easy to see where they went wrong. But it’s also a perfect illustration of why the sunk cost fallacy is so dangerous. Not only does it lead to throwing good money after bad, it’s at the expense of investing time or money into other, potentially better, areas. Doing the mental calculation of whether to continue with a flagging investment, we don’t factor in the loss of alternative options not chosen—or in economist speak, the
opportunity cost
. When you decided to sit through the second half of Glass, you were asking yourself,
will this end up being good or bad
, but what you should have asked yourself is, if I leave is there something else I’d enjoy doing more? You could’ve gotten a drink with a friend or stared at a mailbox or done any number of other things that might have been better. There are a lot of other psychological factors at play in these situations. Accepting a sunk cost as a loss causes us psychic pain. We have to accept that it might’ve been a waste. But it’s worth remembering that leaving a bad investment prematurely isn’t a waste, particularly in business, because it can allow your company to survive when it otherwise might not have. There’s also real value in the lessons learned from mistakes made—hopefully you didn’t have to pay too much for them. If justifying a past investment plays a large role in a decision, it’s a worthwhile exercise to try to look at it again with fresh eyes. And if you have to accept a sunk cost as lost, your best bet might be trying to recognize the value in the experience.
Have you invested a lot of time or money?
If you left now would you lose all your investment?
Is the only way to make your investment worthwhile to invest more resources?
Have you considered the other potential opportunities that you would miss out on by proceeding?
If you could go back would you make the same investment?
Are you diving after sunk costs?
If you’re questioning an investment, examining your thought process will help clarify how you should proceed, one way or the other.
Halfway through a movie have you ever thought,
should I just walk out?
At this point you’re far enough in that you probably won’t get a refund, so instead you sit through the rest hoping it’ll get better or come together in the end. But it doesn’t. And now you’ve wasted twice as much time on a bad experience. *cough*
*cough* Your initial investment of the ticket price was already lost, but it was enough to have kept you in your seat. Worse still, every minute that followed was a further investment in a losing proposition, making you less and less likely to leave. You tumbled into the psychological pitfall known as the sunk cost fallacy. Pioneering work in the field of behavioral economics by Kahneman and Tversky demonstrated that humans value avoiding losses more than potential gains. When we’re weighing those potential outcomes, we don’t treat them equally. This phenomenon, called loss aversion, underpins many bad sunk cost decisions. We naturally place higher value on past investments—whether that’s time, money or effort—that allow ourselves to make decisions that would otherwise be irrational. In the early 2000s when HMV started to see sales decline during the rise of online music sales, rather than developing their own competing online platform, they doubled down, acquired additional brick-and-mortar stores and diversified their product offering to offset their music losses. By the time HMV started their online store in 2010, they were already too far behind other online retailers to catch up.
Leaving a bad investment prematurely isn’t a waste, particularly in business, because it can allow your company to survive when it otherwise might not have.
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