Breaking Free from the Sunk Cost Trap in Business and Life
As an healing and leadership coach, I’m excited to share this important article about the sunk cost fallacy. This concept is crucial for leaders and business owners to understand, as it can significantly impact decision-making and overall success.
While this might not be the most exciting topic to dive into, it’s crucial to understand how avoiding certain mistakes can save you a lot of time, money, and energy in the long run.
In this article, we’ll cover:
- What the sunk cost fallacy is
- The science and psychology behind it
- How it shows up in real life
- Why it matters for business owners and leaders
- How to avoid falling into this mindset
With that said, let’s jump into the first part. So, what exactly is the sunk cost fallacy?
What is the Sunk Cost Fallacy?
The sunk cost fallacy is when we keep putting time, money, or effort into something just because we’ve already invested a lot in it, even if it’s not working out.
It’s like trying to fix an old car that keeps breaking down, just because you’ve already spent so much money on repairs. This way of thinking can cause big problems for business owners and leaders. It can make them stick with bad ideas or projects that aren’t working, instead of trying something new that might work better.
The term “sunk cost fallacy” started in economics but became more popular in psychology and behavioral economics. Psychologists Hal Arkes and Catherine Blumer brought attention to it in their 1985 paper, “The Psychology of Sunk Cost.”
Next, let’s talk about why we find ourselves in situations where the more we dig into them, the bigger the cost.
Why Do We Fall for the Sunk Cost Fallacy?
There are a few reasons why our brains trick us into the sunk cost fallacy:
- We don’t like to lose: People really don’t like feeling like they’ve lost something. Sometimes, we’d rather keep trying with something that’s not working than admit we made a mistake.
- We want to finish what we started: It feels good to complete things. This can make us want to keep going with a project, even if it’s not a good idea anymore.
- We don’t want to waste things: Nobody likes to feel like they’ve wasted time or money. But sometimes, trying to avoid waste can actually lead to more waste in the long run.
- We get attached to our ideas: When we work hard on something, we can start to feel really connected to it. This can make it hard to let go, even when we should.
Too many of us choose careers, relationships, or places to live simply because we never challenge the thoughts we have around those ideas.
— Denise G. Lee (@DeniseGLee) November 20, 2024
For example, we might think, "I need more freedom in my work," and decide that becoming a business owner is the answer. Then, we see others…
The Science
Scientists have studied the sunk cost fallacy to understand why our brains work this way. They’ve found that it’s related to how we process emotions and make decisions.
One study showed that the part of our brain that deals with emotions lights up when we’re faced with sunk cost decisions. Interestingly they found that people who usually follow social rules and are responsible (showing high levels of agreeableness and conscientiousness) are more likely to fall into the sunk cost trap. This suggests that our feelings as well as our life script plays a big role in why we fall for this fallacy.
Waiting for Rewards: How Time Spent Influences Choices Across Species
Another interesting finding is that even animals like rats and pigeons can show sunk cost behavior. One particular study looked at how different animals, including mice, rats, and humans, make decisions about whether to wait for a reward, like food or videos.
Researchers created tasks where subjects had to choose between waiting for a reward or moving on to try for another one. In one version of the task, subjects could change their mind after deciding to wait, which helped scientists understand how “sunk costs” affect their choices—meaning they are less likely to quit waiting if they have already spent a lot of time doing so.
The findings showed that the longer subjects waited, the more likely they were to stick it out for the reward, even if the waiting time was the same as before. This suggests that their decision to continue is influenced by both how long they’ve waited and how much time is left, not just how close they are to getting the reward. In addition, it tells us that it might be a deep-rooted part of how brains work, not just a human problem.
The Psychology
Understanding the psychology behind the sunk cost fallacy can help us avoid it. Here are some key points:
- Loss aversion: Our brains are wired to avoid losses more than seek gains. This can make us stick with bad investments to avoid feeling like we’ve lost.
- Commitment and consistency: We like to see ourselves as consistent. This can make it hard to change course, even when it’s the right thing to do.
- The endowment effect: We tend to value things more just because we own them. This can make it hard to let go of projects or possessions, even when they’re not useful anymore.
- Escalation of commitment: As we put more into something, we can become more committed to it, even if it’s not working out.
By understanding these psychological factors, we can be more aware of our own thinking and make better decisions. Now, let’s talk about how the sunk cost fallacy shows up in our work life.
The Sunk Cost Fallacy in Business
For business owners, the sunk cost fallacy can show up in many ways:
- Sticking with old technology: A company might keep using outdated software just because they spent a lot of money on it, even if new software would save time and money in the long run.
- Continuing failing projects: Sometimes businesses keep working on projects that aren’t succeeding, just because they’ve already put so much time and money into them.
- Holding onto underperforming employees: A manager might keep a worker who isn’t doing well, just because they spent a lot of time training them.
- Not changing strategies: A business might stick with a marketing plan that isn’t working, just because they’ve already invested in it.
Famous examples of sunk loss in business
- WeWork, the office-sharing company, continued to expand aggressively despite mounting losses, partly due to the billions already invested. This led to a failed IPO in 2019 and near-bankruptcy.
- In 2022, Netflix continued investing in its gaming division despite low user engagement, likely due to the significant resources already committed.
- The Concorde supersonic jet project, which continued despite mounting losses, gave the fallacy its alternative name.
By recognizing these situations, business owners can make better choices and avoid wasting resources.
Why is Understanding the Sunk Cost Fallacy Important for Leaders?
For leaders and business owners, knowing about the sunk cost fallacy is super important. Here’s why:
- Better decision-making: When you understand the sunk cost fallacy, you can make smarter choices about where to put your time and money.
- Saving resources: By avoiding the sunk cost trap, you can stop wasting resources on things that aren’t working and use them for better opportunities.
- Being more flexible: Understanding this fallacy helps you be more open to change and new ideas, which is crucial in the fast-moving business world.
- Improved team leadership: When you can recognize and avoid the sunk cost fallacy, you can help your team do the same, leading to better overall performance.
Let’s take a moment to shift our focus from your work life to your personal life.
The Sunk Cost Fallacy in Our Personal Life
As a life coach for business coach, I’m involved in all parts of your life, including what happens at home. Here are some everyday examples of how the sunk loss fallacy shows up:
1. Keeping Old Clothes:
Suppose you have a shirt that you don’t like—it’s just not your style—but you keep it in your closet because you paid a lot for it or you were told that it is fashionable or “timeless”.
Or let’s get even more real: you keep clothes that are two or three sizes too small. You tell yourself that with enough exercise or extreme dieting (which could put you at risk for a food addiction), you’ll be able to wear them again. But the reality is you might never wear any of it. You’re holding onto those items just because you don’t want to feel like your money was wasted.
2. Finishing an Unfinished Book:
Imagine you start reading a book that you find boring. You’ve already read half of it, so you decide to finish it, even though you’d rather do something else. You’re sticking with it just because you don’t want to waste the time you’ve already spent reading, even if you’re not enjoying it.
3. Attending a Bad Event:
Let’s say you bought tickets to a concert, but the music is terrible, and you’re not having any fun. You might stay until the end just because you’ve already paid for the tickets, even though you’re not enjoying yourself. This is another example of sticking with something because you’ve invested in it, even if it’s no longer worth your time.
Next, let’s talk about signs you may be avoiding quitting because you are a victim to the sunk cost fallacy.
Signs You Are Avoiding Quitting (Even Though You Probably Should)
1. Justifying Continued Investment by Referencing Past Expenses
Imagine you bought a fancy coffee machine for your home office. It was expensive, but you thought it would make your workday more enjoyable. Now, the machine isn’t working well and makes a mess every time you use it. Instead of buying a new one or switching to a simpler option, you keep spending money on repairs because you don’t want to feel like the original purchase was a waste. This is an example of justifying continued investment by referring to past expenses.
2. Feeling Obligated to Finish Something Just Because You Started It
Let’s say you started a challenging puzzle with 1,000 pieces. It’s been months, and you’re only halfway through. Despite the frustration and lack of progress, you keep working on it because you feel obligated to finish it just because you started. This is an example of feeling compelled to complete something simply because you began it, even if it’s no longer enjoyable or practical.
3. Difficulty Letting Go of Underperforming Projects or Investments
Suppose you invested in a new business venture that seemed promising, but it’s been losing money for months. You’re hesitant to cut your losses and move on because you’ve already invested a lot of time and money into it. This difficulty in letting go, despite the ongoing losses, is an example of struggling with underperforming projects or investments.
4. Ignoring New Information That Suggests a Change of Course
Imagine you’re following a strict diet plan that worked well for you in the past. However, you recently learned about new research showing that a different diet might be more beneficial for your health. Even though the new information suggests a better option, you ignore it and stick to your old plan because it’s what you’ve been doing for years. This is an example of ignoring new information that suggests a change of course.
These examples illustrate how our past decisions and feelings of obligation can influence our choices, even when they may not be the best course of action. Now, on to the good stuff—how to avoid getting trapped in the sticky mud pit of the sunk cost.
Break Free from the Sunk Cost Fallacy: 5 Tips for Better Choices
Now that we know what the sunk cost fallacy is and why it happens, let’s talk about how to avoid it with these five tips:
1. Focus on the future, not the past:
When making decisions, it’s important to think about what will happen next, rather than what you’ve already done. This means looking forward instead of backward.
Example: Imagine you bought tickets to a concert, but on the day of the show, you’re feeling sick. Instead of thinking, “I already paid for the tickets, so I have to go,” consider what’s best for your health and enjoyment. It might be better to stay home and rest, even if you’ve already spent money on the tickets.
2. Be honest with yourself:
It’s okay to admit when something isn’t working. In fact, it’s an important skill for success.
Example: You’ve spent months developing a new product line, but customer feedback is overwhelmingly negative. It’s better to admit it’s not working and pivot, rather than pushing forward just because you’ve invested time and resources.
3. Set clear goals:
Before starting a project, decide what success looks like. This makes it easier to know when to keep going and when to stop.
Example: When launching a new service, set a goal like “acquire 100 new clients within the first six months” or “achieve a 20% profit margin by year-end.” These clear targets help you assess whether the service is meeting expectations.
4. Regular check-ins:
Take time to look at your projects and see if they’re still worth doing. Don’t be afraid to change course if needed.
Example: Schedule monthly reviews of each department’s performance. If your brick-and-mortar store’s sales are consistently declining while your online sales are booming, it might be time to consider shifting more resources to your e-commerce operations.
5. Learn from your past mistakes:
Instead of feeling bad about a failed project or decision, think about what you learned from it. This can help you make better choices in the future.
Example: Maybe you spent a lot of money on an expensive gym membership but rarely used it. Instead of beating yourself up about the wasted money, think about what you learned. Perhaps you realized you prefer outdoor activities or home workouts. Use this knowledge to make a better decision next time you want to invest in your fitness.
By following these tips, you can become better at recognizing and avoiding the sunk cost fallacy in your daily life. Remember, it’s never too late to make a change if something isn’t working out, even if you’ve already invested time, money, or effort into it.
Final Thoughts
The sunk cost fallacy is a tricky problem that can affect anyone, from individuals to big businesses. By understanding what it is and how it works, we can make better choices and avoid wasting time and resources on things that aren’t working.
Remember, it’s okay to change course when something isn’t working out. In fact, being able to do this is a sign of good leadership and smart business sense.
So, in what way do you need to let some things go? Or perhaps, how have you learned to be easier on yourself? I would love to know your thoughts. Share them with me using this link.
If you’d like to learn more about making better business decisions and avoiding common pitfalls like the sunk cost fallacy, I’d love to work with you. As an healing and leadership coach, I help business owners and leaders develop the skills they need to succeed.
Also, don’t forget to check out this episode from my podcast, where we dive deeper into managing your time.
