If you are a line manager with responsibility for budgets, chances are you have heard of the 'sunk cost fallacy' or the 'sunk cost effect'. A quick search on 'sunk cost fallacy' will return a stack of articles dealing with the gist of the topic or generally regurgitating Wikipedia. More enlightened journals of record will invoke the most infamous example of the Concorde Project or make reference to Daniel Kahneman’s famous book Thinking Fast and Slow — which if you have not read, I strongly recommend.
With so much material already written on the topic, why revisit? The reason is that I think there is much yet to be added to the literature. In part the 'so what' was alluded to in Kahneman's work who, along with fellow psychologist Amos Tversky a profound thinker who sadly passed away far too young, correctly saw the sunk cost fallacy as stemming from the broader condition of general cognitive bias.
What this means is that unlike the neat conclusions found in many of the articles already produced on the topic, or as common sense would suggest, it is not so simple as 'just cut your losses'. Therefore, the question remains: when a line manager has a program where the costs are outweighing the benefits, why do they persist with the program?
Factors of Fallacy
To cope with the torrent of decisional points we have to deal with in our daily life, we use a series of heuristics or proxies to reduce the cognitive load. In the space of organisational behaviour, this is a process that tends to become more prevalent the higher the org chart we climb. The reason for this is that the Executive Leadership Team or Board of a large organisation could have tens of thousands of specialists working for them and it is impossible to be across the detail of all their work. To prevent analysis paralysis, proxies play a vital role in formulating the myriad complex parts into a conceptualisation about which a decision can be made.
George Pólya's 1945 book, How to Solve It outlined a series of commonly used proxies:
- Visualisation: if you struggle to comprehend something, sketch it.
- Start at the end: if you cannot formulate a solution, begin with the end in mind and see if you can work backwards.
- Give examples: if you find abstract concepts difficult, find a concrete example.
While these techniques can be used to great effect in decision making, they can bring a new range of problems. Key among them is that we end up making poor decisions if our proxy does not give an accurate representation of the problem / opportunity. In the context of sunk costs, there are five psychological factors which can skew our development of an effective proxy.
- Loss aversion:
- Definition: the fear of losing something feels worse than the joy of gaining something.
- Outcome: a line manager will double down on their original decision for fear of losing resources, control etc.
- Framing effect:
- Definition: when change is framed as negative, people will be less likely to pursue it; a positive framing will motivate change.
- Outcome: a line manager will latch onto a positive view of a program of work, making them unable to see the faults and failures in the process.
- Unrealistic optimism:
- Definition: when people think something cannot fail or is bound to succeed.
- Outcome: just one more quarter and the strategy will bear fruit.
- Ego:
- Definition: the drive to promote only favourable views of oneself, an overestimation of ability, an inflated sense of self-importance.
- Outcome: if a line manager sees a project as inextricably linked with their standing in an organisation, they will resist axing it for fear of the impact to their reputation.
- Fear of waste:
- Definition: the fear that by cutting losses, we are wasting resources.
- Outcome: a line manager will keep a project active in the misconception that by holding on the organisation is not wasting resources.
An almost inevitable outcome, when one or more of these biases are in play, is for line managers to resist performance management of a team or changing their strategic direction.
An essential element to understand, when working with line managers to combat the sunk cost fallacy, is that psychological susceptibility to each of these factors is highly correlated to pain association. By this, I mean that where individuals or groups have come to associate pain with the negative outcome of a bias, for example looking bad in front of others (ego) feels painful, they will be more inclined to perpetuate a sunk cost approach. When this happens, additional data is not the magic cure it is often assumed to be. This is because at its core, the sunk cost fallacy is the outcome of an emotional response to a situation.
Coaching people out of this pain association and helping them to gain mastery over their innate bias is exceptionally challenging. In some cases it can only be achieved by a highly competent clinical psychologist — if at all. In this context, awareness is often the best that can be achieved. From there, it is a case of a more senior line manager or the Board bringing in experts to tackle the challenge or move to performance management and eventual replacement if the employee's biases are proving intractable.
Avoiding the Iceberg
Having established the psychological underpinnings of the sunk cost fallacy, it remains to put a plan in place to avoid the organisation striking the metaphorical iceberg. I will go into this in my next column Calling Time on a Sunk Cost. But as a taster, there are three key areas which need tackling to redress the sunk cost fallacy: experience, ongoing costs, seeing over the hill. And on that cliffhanger:
Good night, and good luck.
Further Reading
Kahneman, D. (2012). Thinking, fast and slow, London: Penguin Books.
Pólya, G. (1988). How to solve it: A new aspect of mathematical method, Princeton: Princeton University Press.
