The Sunk Cost Fallacy and How to Avoid It
Imagine that you are a health-food fanatic and you own two juicers. The first is a top-of-the-line, brand-new model that many celebrities own. It cost you $1,000, and it looks fantastic in your kitchen. Your second juicer is a rickety, ugly, second-hand model that you picked up at a garage sale for $10.
You use both juicers equally, and over time you notice that the cheap machine turns out better juice and is easy to clean up. The more expensive juicer gives everything a metallic taste, and takes ages to clean.
Now imagine that, for some reason, you can only keep one of these machines. Which one do you choose?
If you said the $1,000 model, then you’re not alone. Most people would end up deciding to stick with the option for which they paid the most money, and which brings them the most prestige, even if the results it produces are significantly worse. This is an example of the sunk-cost fallacy, and while it’s amusing when it’s applied to kitchen appliances, it can be devastating in the world of business.
Real Example of the Sunk Cost Fallacy
Concorde, the world’s first supersonic passenger jet, was no simple project. It lasted over 20 years and two governments invested multiple billions into its development. For a large portion of that time, all parties involved knew that there was little to no chance of recouping the massive investment, and that the finished plane would not only have a lower capacity, but would also be more expensive on a per-mile basis than other contemporary liners. The project, by all accounts, made no economic sense and yet the project leaders went ahead regardless. Why? The governmental prestige that had been heaped onto the project was clearly an element in that decision, but it also came down to fear: Having spent so much time and money on Concorde, nobody felt as though they could give up before reaping some reward, however meager that might be.
That’s the heart of the sunk cost fallacy. Nobody wants to believe that they made a bad decision. And nobody wants to wave goodbye to money they’ve already invested.
How to Avoid the Sunk Cost Fallacy
So how do you prepare yourself to avoid this trap? As with many fallacies, nobody is completely immune, but in any project, there are a few simple steps you can take to dodge a sunk-cost nightmare. Here are three of them:
1. Discuss Failure
Even in the very early stages of a project, make sure to have failure on the table. Discuss it openly. Certainly avoid it if you can, but make sure that you and your team have considered what you might do if the project doesn’t come together. By considering this early on, you create for yourself a mental “emergency exit” that you can later use if things don’t work out.
2. Weigh Up the Cost of Carrying On
There is, of course, a cost to failure. Perhaps giving up on a project will make you and your team look bad. Perhaps it will cost the company money. Many people shy away from giving in because of these costs, but it’s important to weigh them up against the costs involved in carrying on as well. When you do so, you may find that giving up is a better and cheaper option than staying the course.
3. Make Mistakes Acceptable
Developing a culture in which it’s okay to make mistakes isn’t something that you can do overnight, but it’s a valuable step to take. When people in your organization don’t feel as though they’ll be punished for making mistakes, they are far less likely to try and cover up their errors with further ones.
HB Hot Rods and Hogs was started by Ed Syer in the back of his auto repair shop in Huntington Beach where Ed was building