Don’t you hate trying to make a decision sometimes?!! When the stakes are high, we become obsessed with avoiding failure or loss and draw on all of our resources in a desperate attempt to succeed. Have you ever wondered why? Let me introduce you to sunk cost bias. It is why people stay in unhealthy relationships or fail to move on in their careers. According to this theory, people have a tendency to persist on the same path of action, even when new information indicates that the choice is not the most appropriate. Sunk cost bias can be observed in relationships, business, gambling, investing, retirement planning, and many other kinds of activities.
It’s why people may be stuck in a job they don’t like or are not being treated fairly in – because they’ve invested their time and energy building their skills at the company, or because they don’t want to miss out on the benefits of staying with the company (e.g., health insurance, 401K). It’s why teams spend so much time arguing over moving forward with a bad idea, rather than starting to brainstorm a new solution.
While bias is well-known in behavioral economics and psychology, I don’t think enough people realize how destructive it can be in personal and business decision-making. In decision-making, sunk-cost bias is the incremental effect of taking into account previously expended resources when making a decision. As a result, we are less inclined to more rational thinking and more to emotion-filled thinking.
For example, in a business context, the sunk cost effect would be the tendency for – you – as a decision-maker to justify continued investment in a project based on the amount of resources already expended, even if continuing to invest does not make sense from an objective standpoint such as expected return on investment. The psychological basis for this behavior stems from individuals’ desire to “avoid losses” (loss aversion).
How To Recognize Sunk Cost Bias
- Unflinching attachment to an idea because it’s originally yours: There’s nothing wrong with wanting credit for your work and achievements, but an undue attachment to an idea just because it was yours in the first place is indicative of sunk cost bias. This kind of attachment is detrimental to productivity, as it can blind you to better ideas and courses of action. There is a natural human tendency to irrationally cling to projects that are already in motion. All too often, we’ll forge ahead on a project or task after it’s clear that it isn’t working out. You may have been totally committed to the project when you started, but if new information has come to light since then, and now you’re still sticking with it even though logic dictates that you should stop, then it’s time to pull the plug, cut your losses, and redirect your efforts.
- Low/no return on investment(ROI): This is the most obvious indicator of sunk costs bias in personal and business decisions. Businesses keep pouring resources into a project that has no or low return on investment and most probably ignore the fact that this project has been a failure. Hence, they refuse to pull the plug on such projects because they don’t want to admit they were wrong in starting them, or they may be emotionally attached to them, or simply hope that things will improve in future. This is not just a waste of resources but can also divert attention away from more productive pursuits.
- Lack of future outlook: Sunk costs bias often results from making decisions based on past investments rather than future prospects. If your business is stuck in the past and can’t focus on what’s ahead then you are likely to fall victim to the sunk cost bias. This can be incredibly damaging to a company because it prevents leaders from focusing on what’s important right now. The best way to get over this issue is by taking a step back and looking at the situation objectively. What would happen if you just stopped following your current route? How much would it cost? How much would it save? Would there be any additional benefits from making a change?
- Avoiding making tough decisions because they will require admitting defeat: Now if we dig a bit further, one of the reasons for sunk cost bias is the damage it inflicts on our egos. For the sake of saving face, most of us would rather continue to invest in an endeavor even if it ends up going nowhere and costs a lot than admit defeat, cut our losses, and move on to something else. As difficult as it may be to admit when we have dug ourselves into a hole, getting out of the hole starts with admitting we are in one.
Understanding how sunk cost bias affects your decision-making process can help you avoid it in the future. Here are some ways to start fighting back against sunk cost bias:
- Keep up with key metrics: Maintain focus with key metrics by keeping up with which projects are flying and which aren’t in order to keep your mind clear of any unnecessary information. Focus is crucial!
- Focus on what you can learn from your mistakes: Rather than trying to save face by continuing a bad investment just because you started it.
- Explore the opportunity cost of your current situation: When you feel yourself getting hung up on a sunk cost, take the time to objectively think (or involve someone not emotionally invested in the outcome of your sunk cost) about how choosing a different path will impact your decision moving forward.
- Have a contingency plan in place so that you can walk away if needed. By knowing when and how to walk away, you have a clear pathway to mitigate losses before they spiral out of control. Keep your contingency plans simple, clear, and actionable.
Sunk cost bias affects everyone to some degree. That doesn’t particularly make it any more pleasant, however, and struggling against its effects can be difficult. Once you know how sunk cost bias presents and ways to combat it, you’re on your way towards avoiding its traps.
What tips do you have that have helped curb your own sense of sunk costs?
