Scott H Young

Don’t Forget Sunk Costs, Stupid!


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People are normally fairly intelligent.  Although there are many exceptions, people tend to make rational decisions.  However, there are some decisions that most people get wrong (including me).  There is a whole field of psychology devoted to these non-random acts of stupidity, known as cognitive biases.  I’ve always found cognitive biases interesting, since understanding them is the first step to avoiding making bad decisions.

An extremely common bias is forgetting about sunk costs.  Skipping a more formal definition, a sunk cost is a term from economics to describe money (or time, energy, etc.) that has already been spent in a past decision.  Since the money is gone, it shouldn’t be a factor in making new decisions.

Why I’m Fun at Parties

Giving slightly inebriated lectures about rational decision making at a party is part of my charm.  I’m sure my friends that I explained sunk costs to at a show last Saturday also felt the same way.  It makes a good example of how it’s easy to get tricked into sunk costs, so despite the setting I’ll use it:

My friends and I had spent $12 to go to a show.  We decided we didn’t like the music, but there was another party (and DJ) that we would enjoy more, less than 2 minutes away, for $7.  Some of my friends argued that we should stay here, because we paid $12, so we might as well enjoy the band.

At this point I enlightened them about sunk costs.  Since we had already spent $12, that money was gone, and shouldn’t be part of a decision to stay or leave.  A better way to phrase the decision was to pick between staying at this show for free or going to the other party for $7.  The original ticket price didn’t matter if the transfer to the other party was worth $7 to us.

I was only half-joking when I brought up sunk costs, because I feel it’s a trap many people get caught in with everyday decisions.  Although debating between parties on a Saturday night isn’t too important, it can be incredibly important when making life decisions like what career to pursue, what projects to finish and what degrees to achieve.

Should You Quit the Project?

In simple economic rationality, you should stop any project where the payoff is less than the amount you need to invest to reach that payoff.  So it’s stupid to spend $10,000 on a project only destined to pay out $6000 (assuming money is your only measure of value in this example).

Where this gets confusing is when you introduce a sunk cost.  It’s easy to chase a $3000 payoff when you still need $4000 in investment, if you’ve spent months and years working towards it already.  I’m sure we all know personal examples where we stick with doomed projects out of the misguided desire to finish what we start.

Avoiding sunk costs means you need to remove any past investment from your mind before you make a decision.  In my personal example, this meant forgetting I previously made the (bad) decision to spend $12 on one party, when deciding to stay or switch.  For a project, this means forgetting the time you’ve already spent and focus on what you still need to spend.

I think the sunk cost fallacy is similar to another human bias of valuing the things we have more than the things we don’t.  When you spend months working on a project, you feel ownership of it.  As a result, we make irrational decisions to stick with it, because it’s our project.

Staying with the Degree or Career

A lot of University students need to face a sunk cost problem.  Midway through a degree program, they decide they don’t want a job in their chosen field.  Should they finish the degree anyways or switch?

This is a complicated decision with many factors, so no simple trick can automatically decide the right answer.  However, if you view this problem through the sunk cost lens, you’ll realize that the time already put forwards towards the degree isn’t important.  Whether that time was invested or wasted, it can’t be changed, so you need to focus on the future.

If you were midway through a 4-year Science degree and wanted to switch to Arts, your comparison should be between the 2 years you have left in Science and the 4 years needed for Arts.  Once again, it is easy to bring back the past years and use them as a starting point to justify wasting more time in a failed path.

The same idea could apply with a career.  Your past experience isn’t a factor in staying or switching.  Instead you should pretend you were deciding today, would you pick your old job, benefits and salary or would you pick a different job, with it’s starting pay and benefits.

How to Remember Sunk Costs

I’m just like everyone else in forgetting about sunk costs.  I have irrational attachments to pursuits and projects.  I’m as biased as everyone else.  But I think being aware that you’re likely to make stupid errors means you’re more likely to catch them before they become life-changing decisions.

I believe the best way to remember sunk costs is to pretend you were starting with a fresh decision.  Eliminate the past and pretend you were starting over.  Compare the leftover of one pursuit with beginning the alternatives.  Last Saturday, this meant comparing a free social where the music was mediocre with a good party which cost $7.

Obviously, sunk costs are just one tool for rational thinking.  They don’t automatically make the right decision.  For example, I stayed at the $12 social because my friends decided to stay.  Switching to a party by myself wasn’t worth $7.  You might also stay with projects for the psychological satisfaction of completion (which is a hard value to quantify) or you may stay in a path for reasons that can’t be measured.  But at least being aware of sunk costs gives you a bit more control.


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13 Responses to “Don’t Forget Sunk Costs, Stupid!”

  1. I know how it feels, Scott. I always get “the look” from many people when I talk about sunk cost bias in situations such as the show situation you mentioned.

    For another take on the Sunk Cost Bias, I wrote an article that might interest you and your readers:
    Sunk Cost Bias: How It Hinders Your Life and 4 Ways to Overcome It.

  2. Excellent work on Sunk Costs, Scott. Your party story is a powerful example.

    Here is my question though. If you are in business, would you not want to take advantage of the fact that people feel the effects of a sunk cost? For example, satellite companies charge a good amount for the dish and receiver. This becomes a sunk cost. Is this not good business strategy to help prevent people from leaving?

    What do people think about this sort of business strategy?

  3. Bobby Rio says:

    Seth Godin talks a lot about this in his book The Dip. Sometimes quitting is the most productive thing you’ll ever do. The truly successful people know when to quit and move on.

  4. J.D. Meier says:

    Know when to hold them. Know when to fold them.

    I’ve seen people eat them self sick with dessert, because they already paid for it. What – stop? But I already paid for it …

  5. Scott Young says:

    Success Professor,

    A lot of persuasion is activating the biases people have under the surface, and I would say that this is no different. You need to be careful, however, as manipulating biases so that people make poor decisions for themselves can be a bit of a gray zone in the ethical front.

    -Scott

  6. Anon says:

    Maybe I still don’t understand sunk costs,
    but I think a better way to describe the situation in your party story is: do you want to spend a total of $12 (to stay at the show, and see if it turns out to be good), or do you want to spend a total of $19 (leave the show, try out the next show and have more fun).

    I believe that understanding the entire cost (including sunk costs + future costs) is more practical in a sense, because we only have a finite amount of resources (i.e. money or time). This gives you a more realistic view of whether it is worth it or not and eliminates the feeling of later when you realize that you spent too much money on entertainment. (otherwise we’d always be going for the $7 second show because it seems so cheap)

    What do you think?

  7. Scott Young says:

    Anon,

    Actually that’s precisely the sunk cost fallacy.

    See, the timing of the decision is when it is most important:

    In my example, I was making the decision between staying and leaving, AFTER I had already purchased the ticket and was at the party (i.e. I couldn’t get a refund). The first $12 was already spent, so my decision could not include the $12.

    Instead, the actual decision was between $0 to stay at the current show or $7 to go to the one next door.

    If you were on a strict budget, or had absolutely no money, then the decision would still be the same (stay where you are). However, the fact that you wasted $12 initially has nothing to do with the future decision.

    -Scott

  8. [...] Don’t Forget Sunk Costs, Stupid! [Scott H Young] [...]

  9. ReaderG says:

    Good Idea.

    But it led to me making such a stupid decision. The badgers had ten times more yards than us during half-time at the Michigan/ Wisconsin game today (it was 19-0), so I left the stadium to go home and finish up a few things before I go out tonight. I figured I paid for the ticket, but I shouldn’t really evaluate that because I was having a shitty time at the game.

    The score is now 27-19, Michigan. Rule: sunk costs don’t apply to attending sporting events.

  10. Scott Young says:

    ReaderG,

    Sunk costs aren’t restricted to one domain or another, you had some bad luck by missing out on your sports game, but the problem doesn’t have to do with sunk costs.

    A good sports-related example for sunk costs is if you’ve paid $50 for a sports ticket, and your ticket is stolen–will you pay for another ticket?

    Many people would say no, incorrectly reasoning that $100 is too much for a ticket. However, the first $50 for the ticket is already gone, the question is no different than whether you would have paid $50 for the original ticket.

    My example discounts the fact that you have relatively less money after paying for the first ticket, which would be a factor, but otherwise the reasoning is sound.

    -Scott

  11. [...] it’s presented in textbook format but it’s very hard to acknowledge it when it comes to sunk costs in your own life. In other words, you’ve already invested time and resources into your situation, so you [...]

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