In theory, companies are meant to act rationally, efficiently and in their own economic self-interest. But humans manage them, so they succumb to irrational thinking. The sunk cost fallacy is one of the most popular forms of irrationality. It’s a staple topic in introductory economics classes. And it’s a key cultural trait of badly-managed companies.
If you have ever heard someone at work say:
We don’t want to have done A in vain…
We need to get all our money’s worth from B…
We already have technology C in place, we don’t want to waste that investment by changing to technology D…
Then you have seen the sunk cost fallacy at work.
What are sunk costs?
Sunk costs are costs we have already incurred and cannot recover.
In our personal lives, sunk costs include:
- Non-refundable concert tickets
- And terminally-unhappy multi-year romantic relationships.
In business life, sunk costs include:
- Investments in training and developing staff
- And annual contracts with technology companies.
Once we spend sunk cost money (or time), it’s gone. No amount of rationalizing can bring it back.
What is the sunk cost fallacy?
If we make decisions that rationalize our past investments, instead of maximizing our future gain, we succumb to ‘the sunk cost fallacy.’ Sunk costs are irretrievable, so we shouldn’t let them influence our future decision-making. But we do. We allow our past investments of time and resources to continue to commit us to bad decisions. We throw good time and money after bad:
- We stay in the wrong jobs, out of inertia.
- We stay in bad relationships, out of habit.
- We go to concerts, even if we no longer want to.
- And we stick to legacy technologies, even if they’re not meeting our company’s needs.
We do all these things because we worry about wasting time and money that we have already spent. And we don’t want to admit that our past decisions were bad ones – especially if we made those past decisions at work, as managers. By trying to ‘save face’ and avoid waste, we waste more time and money than we sunk in the first place.
In our personal lives, the sunk cost fallacy can be a benign waste of time, driving us to play Farmville for hours on end. But at companies, sunk costs can morph into a culture of rationalized management that hampers growth.
How companies succumb to sunk cost culture
Companies succumb to sunk cost culture when managers:
- Are not aware of the the sunk cost fallacy
- And are not rewarded for identifying (or combating) sunk costs.
These management problems evolve at companies that:
- Reward employees for facetime instead of results
- Don’t offer useful management or business training
- And treat management as a status symbol instead of a business function.
How companies can combat sunk cost culture
The easiest way to combat a sunk cost culture is to:
- Educate employees about the sunk cost fallacy
- And remind managers that good management isn’t about saving face, it’s about getting results.
The best way to do that is to admit that you’ve been doing things wrong and cut your losses.
This is, of course, easier said than done. But starting to think (and talk) about the sunk cost fallacy at work is the only way you’ll be able to solve it. Sharing this article with someone at work could be a good way to get started.