The Sunk Cost Fallacy

A sunk cost is something you have spent that is gone and you cannot get it back.  It’s a concept we are all pretty familiar with. But it doesn’t have to just be money.  It can be anything of value.  It can be your time, it can be favours asked for and received, it can be financial expenditure.  Anything that has a cost to you that you cannot recover can be classed as a sunk cost.

The sunk cost fallacy involves making future decisions based on irrecoverable costs rather than on whether what you are about to spend is the best choice now. It is allowing what is past to dominate what is future. We shouldn’t do this and yet, all too often, we do.

You may recall from our article on assumptions that there is a concept known as a heuristic.  A mental shortcut we take to help us make decisions quickly.  A way we stop ourselves having to go through the mental effort of making a decision from scratch, weighing every piece of evidence against the others every single time.

The sunk cost fallacy is one of the most damaging heuristics that we are all prone to falling victim to from time to time.

Let me give you an example..

A person starts a company and invests all of their savings into developing a proof of concept, a minimum viable product that shows that the problem they are looking to address is indeed solvable.

They take that MVP to a number of investors and eventually get the financial backing they need in order to develop it into a fully functioning product they can hopefully go on and sell.

Only as the product development goes ahead, and more and more of the investors’ money is spent it begins to look like early testing suggests that users are not responding well and do not see the value.

At this point our fictional founder has some decisions to make.

Do they push ahead despite growing evidence they have gotten the product wrong after all they have spent a fortune on getting where they are and they might as well finish it now they are so close?

Or do they stop, re-assess the situation in as objective a manner as they can, and make an informed decision as to what the best course of action is? And where that action, painful as it seems, might be to go back to the drawing board and start again?

Clearly the latter is the better idea, but the former is much more likely.

From the sidelines looking on it's easy to see that they should stop and reassess. But for most people when they are in this situation it becomes a lot more difficult. Walking away from what we have done is is hard. We have formed attachments. We've spent all this time & money. Surely it can't be that bad…"

And in a lot of ways those are all reasonable things to think.

If they are guided by actual evidence and not simply the desire not to have to write off the money already spent.

The sunk costs.

Let me try a different example.

You get out of bed one fine summer morning and head downstairs to make a cup of coffee.  On opening the cupboard door you realise that you are actually out of coffee. So you throw some clothes on and set off walking to the shop.

Only when you are almost there, you remember that the shop is closed.

Do you stop walking and then either go home or to a different shop?  Or do you keep going to the shop you know is closed because you might as well, you’re already most of the way there. It’d be a waste of all that walking if you didn’t finish what you’ve started.

When we frame it that way, it becomes pretty clear that a sunk cost is absolutely no justification for carrying on with something.

Yet we all do it.

We’ve all finished what was on our plate even though we were kinda full already. 

Those of us that are old enough to have used actual phones have carried on listening to the phone ringing at the other end knowing full well no-one was going to pick up and I suspect that I’m not the only person to have sat through a movie I wasn’t enjoying because I had already paid the ticket price.

The sunk cost fallacy is everywhere, and it is more prevalent than ever in the world of tech  start-ups.

Perhaps you have employed someone who clearly isn’t working out, and rather than making the tough, but undeniably correct decision to let them go you stick with them because it was an awful lot of work to get them in the first place, and you’ve paid them quite a lot so far.

Perhaps you are marketing your product using Google ads and they are not working out to be as effective as you were initially hoping?  Do you stop. Or do you keep paying because you're already invested so much and… maybe it will get better?

Perhaps your business is right at the very start of it’s journey and you have invested several thousands of pounds into consumer research to see if your assumptions about your idea are correct. Your product is not selling well. Do you go back and explore where you went wrong and change things? Or keep investing in along the same lines because you can't change courses now?

It’s not an easy thing to discount any sunk costs before making a decision. Accepting those costs are actually lost is a tough thing to do. None of us want to appear wasteful, and there is another heuristic at play here as well. That of optimism bias.

But that’s a subject for another time.

If you’d like to have a chat about your business and see if I can help you navigate past some of the many pitfalls that exist for the unwary please get in touch.