SUNK COST FALLACY
Sunk cost is the cost that has been already incurred or lost and cannot be retrieved. This cost can be time, money or effort to do something.
Sunk cost fallacy is an effect where people tend to make decision based on past cost instead of present and future costs and benefits. Let’s understand this with a real-life example.
Consider buying food from a hotel. If there is food left even after being full, we tend to finish the food forcefully. Even though satisfied, we still finish the food to get a feeling of using the maximum potential of the cost spend on the food. For this emotional accomplishment, we are ready to be uneasy for a period of time.
EFFECT
The effects of this problem may not be visible in a short term. But in a long-term perspective, it has a large effect which most of the time goes unnoticed. It is irrational to use irrecoverable costs as rationale for making a present decision. This affects a number of different areas in life.
CONCORDE, A CASE STUDY
A well-known case of the sunk cost fallacy touching large-scale decisions was coined the “Concorde fallacy” based on the business case study of Concorde Aircraft. In 1956, the Supersonic Transport Aircraft Committee planned to build a supersonic airplane called the Concorde. French and British engine manufacturers and governments were involved in this project which was estimated to cost almost $100 million dollars. Once the project started, it was clear that there were increasing costs of production and maintenance and that the financial gains of the plane, once in use, will not cover them. Yet, the project continued. The manufactures and governments followed through on the project since they had already made substantial financial investments and dedicated a lot of time to the project. Eventually, this led to millions of dollars being lost, and Concorde operated for less than 3 decades.
This example shows the effect of sunk cost fallacy in large scale. Even, the governments in this case were not resilient against the effect. It is easy to see that significant amounts of money, time and effort are wasted because the sunk costs.
EMOTIONAL OVER RATIONAL
The main reason for this effect is the emotional control over the rational decision makings. Humans tend to make emotional decisions over rational ones. The feel of guilty or regretful on a past cost and trying to recover it through some vague criteria backed by irrational decisions creates this effect. In most scenarios, impact of loss is higher than the impact of gain.
OTHER EXAMPLES
1. Most people tend to follow a stream in education even though they feel they are not interested in it because of the capital and money already invested in it. This causes more lose in money as well time. It also adds to the misery.
2. One of the more commonly used example is of watching a movie in a theater. By the 1st 30 minutes, you understand the movie is bad. But since the ticket is already paid, we tend to stick to the end of the movie. This is a waste of time as the capital loss incurred cannot be covered by the time lost.
3. In a business trying to cover the loss made on a poor product by investing more on it without doing a study on its feasibility is poor judgment and can be explained as a sunk cost fallacy. The case study of Concorde Flight given above is an example for this.
4. Investments in a company through stock market also sometimes shows the example of sunk cost fallacy. When the price of the share of a company goes down, to avoid the loss, people tend to buy more shares and average the buy price. When this is done without considering why the crash happened or without any fundamental or technical study on the company, the chances are of losing more money.
OVERCOMING THE HURDLE
Since the sunk cost fallacy is thought to be caused by our desire to avoid negative emotions, we should try to take our emotions out of the equation when making a decision. However, emotions are influential and tough to ignore. Always evaluating any scenario through a third person view helps. Rational thinking over emotional can only be achieved through practice. Avoiding sudden decisions will also help.
REFERENCES
1. Thaler, R., Toward a positive theory of consumer choice, Journal of Economic Behavior & Organization (1980), 1(1), 39–60.
2. Blasingame (2011, October 3). Beware of the Concorde fallacy, Forbes. Website-https://www.forbes.com/sites/jimblasingame/2011/09/15/beware-of-the-concorde-fallacy/#5655b8334e22