You have invested $10,000 into a hot new energy drink eggnog stock that you heard would take off like Santa’s sleigh. You’re not sure why, but the stock’s performance hasn’t done what you expected. In fact, you are down over 20% after the first week. Your friends are all telling you to sell, but you’ve already invested this much into it and still think that there is a chance that it can rebound – you decide to just stick it out. Over the next few weeks, the stock tanks, but each day, you keep thinking about the $10,000 that you invested and hope for a rebound to get that money back. In the end, the company folds and you lose the whole investment.
This is an extreme case of The Sunk Cost Fallacy.
The Sunk Cost Fallacy is the tendency to continue to invest resources such as time, money, or energy into a decision even when it becomes clear that this decision is not in one’s best interests. When we make a significant investment, it becomes more difficult for us to walk away from it. Past investments heavily influence present and future decisions, regardless of the potential benefits.
This bias is frequently seen within organizations and the continuance of certain projects that, to an outsider, may seem doomed from the start. For example, a company that continues to pour a substantial amount of time and money into a research project that has failed to produce the expected return. Prior investments can weigh so heavily on the minds of decision-makers that they start to ignore warning signs and continue pouring more into the project to see it through.
What’s There to Lose?
A related concept, loss aversion, may contribute to the occurrence of the Sunk Cost Fallacy. For some, the fear of acknowledging a loss can lead to the persistence of a failing project in hopes that a further investment will eventually turn the tide (think about the story at the beginning of this blog). Humans are often more motivated to avoid a loss than to acquire an equivalent gain, making it difficult to give up on prior investments seen as a loss – particularly if there is even the slightest chance that the loss will not be realized (i.e., that the stock will rebound or that the research will have a miraculous breakthrough).
Emotional attachments are another factor making it difficult to walk away from investments. Individuals often develop emotional attachments to certain projects or decisions which can cloud their judgment. Making an objective assessment of the current and future state of a project becomes challenging when prior investments that carry an emotional element with them weigh heavily in the decision-maker’s mind.
For organizational decision-makers, public commitments intensify the sunk cost fallacy. Typically, people would rather not admit to a failure. In some cases, this fear of failure is enough motivation to stay the course regardless of the potential consequences. Managers can fall into this trap especially when they assume their organization places a high value on saving face. When the pressure of maintaining a certain reputation comes into play, managers may choose to continue with a sunk cost despite the red flags popping up in the process. Taking accountability for a mistake may be more daunting than continuing with a failed project.
The Art of Letting Go
One of the best ways to combat the sunk cost fallacy is through training. Educating employees on common biases within the workplace and training leaders to prioritize accurate decision-making based on the best potential future outcomes rather than their reputation. Organizations can often avoid any further losses by fostering the right organizational culture. When decision-makers feel comfortable admitting to a sunk cost, further investments into failed projects can be avoided.
The Lantern Group has worked with organizations for over 25 years training employees and leaders on different behavioral science principles to improve the workplace. If you are interested in improving communication, understanding human motivation, and mitigating biases in your organization, contact us today for more information on how we can partner with your organization.