A sunk cost is any past cost that has already been paid and cannot be recovered. The fallacy is that we take this paid cost into account when making decisions for future things, where it actually shouldn’t play any role into the business’s decision making proces. For example, a company has invested a million dollars into a new software product. This money is now gone and cannot be recovered, so it should not be taken into account.
Personally we’re also prone to this error: even though you don’t have the energy for it, if you paid for tickets to go to a concert, you feel you have to go because otherwise the money is wasted. Another one: you want to finish your plate of food in a restaurant without being hungry anymore, because you already paid for it.
There are two specific features of the sunken cost fallacy that are worth mentioning and might help with detecting these situations:
- After investing, we tend to be overly optimistic about future benefits. In other words: the more it cost us in the past, the more we expect to receive from it. This obviously makes it hard to quit.
- After investing, we tend to feel more responsible for the future outcome, which makes it even harder to change plans.
It is important to notice the situations where you’re tempted to make decisions based on previous investments. They simply shouldn’t be taken into account. I don’t want to waste your time this morning with lots of examples, but if you’re up for it, this is a good read about the topic.