Probably the most human error in judgment
At the beginning of this article series I would like to start with probably the most human error in judgement: The “Sunk Cost Fallacy“.
Sunk costs are costs incurred in the past which are irretrievable. They should not be considered when deciding whether it makes sense to pursue a project or topic further.
People tend to attach great emotional importance to these sunk costs. As long as we are not aware of the Sunk Cost Fallacy, we do not rationally and objectively compare the costs and benefits of the future. We can still influence these, but this is not possible in the past.
The Sunk Cost Fallacy is in our everyday life
Usually the Fallacy begins with sentences like “We have already spent so much money/time, we can’t just …”. Yes, we can. We have to. But let’s go away from work projects and money for the sake of understanding. Let’s look into our everyday life:
- Have you ever eaten the plate empty even though you were full?
- Have you ever read a book to the end or watched a movie to the end, although you were bored with it?
- Have you ever stayed together with a person just because you’ve been together for so long?
Then you fell for the Sunk Cost Fallacy! We should only ask ourselves:
- Do I have more advantages than disadvantages if I eat this plate empty? No, I only have disadvantages. I get fat, I feel full and uncomfortable, get heartburn. There is no reason to eat the plate empty, I am not hungry.
- Do I have more advantages than disadvantages when I finish this book? No, I only have disadvantages. I’m wasting a lot of time that I could use differently with something that bores me and is unnecessary.
- Do I have more advantages than disadvantages if I stay with this person? No, I mainly have disadvantages, we argue, have different interests and no joie de vivre. There is no reason to stay together with the person.
What we do instead – we think:
- I paid for the plate of food, then I have to finish it, otherwise it wasn’t worth it
- I’ve already spent so much time on the book, that would have been a waste of time
- We’ve been together for 5 years now – do I really want to throw this time away?
This is a false conclusion – in this case we cannot retrieve time or money that has been spent, they are irretrievably lost. Only the measurable and influenceable parameters of the future should guide our decision. Leave the book when you can use the time better, leave the plate half full when you feel better. [Only with love – you should be sure that you know all parameters that can be influenced and future parameters ;-)]
The Sunk Cost Fallacy in the Business World
In business, that’s how it would be put: The continuation of a project must depend exclusively on influenceable benefits and expenses, not on irretrievably lost costs in the past.
Example: We have purchased a tool that has devoured a lot of money. Let’s say 10.000 Euro. Introduction and usability are a disaster, the tool is unusable. Further 100.000 Euro investments and many personnel changes did not bring success. Now we have action options: for further 50,000 Euro the tool will be improved with predominantly negative chances of success or for 50,000 a completely new tool will be acquired, with which there are proven better chances of success.
People tend to think: “We have already invested so much money in the tool that it would be a shame that all this was in vain. Also, the tool is much more expensive than the tool at the beginning. The correct option, however, would be option number 2.
Of airports and airplanes
In the press there are numerous examples of the Sunk Cost Fallacy. Especially among politicians. The airport Berlin Brandenburg for example is a billion Euro grave and there is no end in sight. But no politicians dare to say: Ok, demolition and new construction would be the better option. The people would scream: “But 5.2 billion have already been invested! (status 02/2019), because they all fall victim to the Sunk Cost Fallacy. Only the factors of the future that can be influenced should be relevant for this decision.
On the Airbus A380, on the other hand, things went differently: The estimates were wrong, the plans and assumptions did not work out. The assumptions of the competition had. Despite costs running into billions, it is now being discontinued. Why? Because the sunk costs don’t matter. Only the costs and benefits of the future play a role. And they are clear. This is where the german proverbial version of Sunk Cost Fallacy comes in: Lieber ein Ende mit Schrecken, als ein Schrecken ohne Ende (Better a horrible end rather than a neverending horror)
So, if in the future you have to decide on the fate of a project: Be the Airbus A380 – and not the airport BER. Be prepared for a headwind, because the stupid people will speak of a disaster. But the smart people know the Sunk Cost Fallacy and can understand your decision.