Last week I looked at the psychological underpinning of the sunk cost fallacy — which I would encourage you to read first if you have not already. The cliff-hanger on which I left off was that when line managers or boards are falling foul of the sunk cost fallacy, lack of 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. This begs the question, if not data, then what can be used to put a plan in place to avoid the organisation striking the metaphorical iceberg?
Experience Vs Calculation
In a 2021 study, Evaluating the Sunk Cost Effect, it was found that:
stock of knowledge and experience is predictive of susceptibility to the sunk cost effect, rather than computational ability.
Ronayne et al. 2021.
This research is important as it contrasts with received wisdom about how we have long viewed the sunk cost effect. The difference is that the common approach is to ensure line mangers or the board are presented with a rich set of data about the situation, from which they use algorithmic thinking abilities (fluid intelligence or gf) to calculate whether continued investment is appropriate or if the organisation should call it a day on the project.
What Ronayne et al demonstrated was that experience and knowledge (crystallised intelligence or gc) in a specific domain — Operations, IT, Finance etc. — emerge as the key element of the ability because the thinking power necessary to override emotion or bias is relatively low. Therefore, a person with relatively low fluid intelligence, but deep experience, will be more effective in making a sound cut or continue call than someone of limited experience but high fluid intelligence. No, it is not the grey hairs in me talking, experience matters in decision making in a way that genius cannot mimic.
Of course, the ideal is a genius with deep experience — but they are rare. Yet most organisations will have access to stocks of knowledge in their leadership ranks (not forgetting informal leaders) which can be drawn upon. These stocks of organisational experience, more than merely analysing raw data, is key to resisting the negative pull of the framing effect which so often accompanies a sunk cost decision.
In addition to hiring for experience, having a good psychology advisory is of considerable benefit. This is because there are measurable traits which are highly correlated with the sunk cost effect (loss aversion, framing effect, etc. — see A Fallacy of Resourcing for a detailed list). Because of this, an organisation's officers, assisted by a psychology advisory, can assess if line managers — or the officers themselves — are more or less likely to engage in sunk cost fallacy behaviour. From this position of awareness, steps can be taken to help with coaching, or in extremis replacing, key individuals who may be keeping an organisation locked in a kind of Groundhog Day when it comes to cutting the cord on a project which will not yield the benefits promised.
Seeing Over the Hill
The latest film about Napoleon by Ridley Scott is a travesty of historical story telling — but a masterpiece of film making. I'll leave historical analysis of the film to others, but the film is relevant because it reminded me of Napoleon's nemesis — the Duke of Wellington — who famously remarked:
All the business of war, and indeed all the business of life, is to endeavour to find out what you don't know by what you do; that's what I called "guessing what was at [sic] the other side of the hill."
The critical error that line managers and boards make in assessing their strategic options regarding sunk costs is in thinking that the need to cut a failing project is only obvious in hindsight. As a result, there tends to be resistance to the so-called 'nay sayers' and 'pessimists' who counselled likely failure from the outset. It also increases the risk that the move to cut sunk costs will only result in more wasted resources because what caused the original investment to be a failure was never understood.
Yet reframe the thinking of 'negative people' as pragmatism, and the optimism of the 'can do people' starts to look increasingly like one of the five psychological factors that drive the sunk cost fallacy — loss aversion, framing effect, unrealistic optimism, ego, fear of waste. Once this pragmatic and sound reframing has occurred, the other side of the hill comes sharply into view because teams skip the Kool-Aid and instead drink a bracing dose of reality. Unromantic and for certain psychological types devoid of optimism, but when embraced it is an essential mindset for strategic thinking.
An example of this is the case of an organisation that decides to double operating costs when there is no plan to drive customer engagement, only the unrealistic optimism inherent in 'build it and they will come'.
In the context of delivering a new product and 'they will come', what does not need hindsight to make clear it will fail is that without a way to drive stakeholder adoption — above and beyond the organisation conjuring up a product so irresistible that a hitherto untapped audience comes flooding in — the strategic goal was always unrealistic. Leading to a conclusion that is available before the project's launch — the plan for success is going to end in a sunk cost that will need to be cut.
While serving as Commander of Multi-National Force — Iraq, General David Petraeus had a picture hanging on his wall titled Stampede. This image depicted cowboys trying to corral charging cattle who were in a state of frenzy. When asked about the meaning of the work he observed: 'What I need around me are people who are comfortable in a stampede.' Situational awareness, and the capability to deploy it, is an essential part of creating that sense of comfort and speaks to the three must-haves to avoid a sunk cost trap in the first place or to extract an organisation from the mire of sunk costs once they have been incurred.
Personnel
As I outlined in A Challenging Time for Talent Management, hiring the right people is the critical first step in Leading Change and Managing Complexity. For organisations seeking to avoid, or that are retrospectively facing a sunk cost situation, assessing line managers and board members for their likelihood of being bias-primed or having an impulsive response is vital. The key takeaway is that experience matters and is of more value in overriding a biased response than thinking ability. This is because the thinking power necessary to override bias is relatively low.
Planning
Given organisations do not function in a vacuum, line managers and boards are often faced with the ongoing cost reality. That is, they may be willing to cut a project but are ultimately unable to do so because the organisation is reliant on the system or service. Therefore, avoiding sunk costs, or cutting losses once incurred, first requires the identification of the sunk costs and programs / teams that contributed to them. Second, it is necessary to determine if the program / team is needed or can it be cut / transitioned. In the context of the Concorde, that involved passengers flying on alternative aircraft.
Strategy
When a Board and Executive Leadership Team engage in thorough strategic planning, foresight goes up exponentially. A process that is sometimes referred to as seeing over the other side of the hill. When this is done effectively, an organisation may still end up in a future sunk cost scenario, but it will be well positioned to cut its losses with minimal disruption to strategic goals.
Good night, and good luck.
Further Reading
Croker, J. W. (1884). The Croker Papers: The Correspondence and Diaries of the Late Right Honourable John Wilson Croker, LL.D., F.R.S., Secretary to the Admiralty from 1809 to 1830,. (L. J. Jennings, Ed.), Vol. III, England: J. Murray, 1884.
Frederick, S. (2005). Cognitive Reflection and Decision Making. The Journal of Economic Perspectives, 19(4), 25–42.
Pólya, G. (1988). How to solve it: A new aspect of mathematical method, Princeton: Princeton University Press.
Ronayne, D., Sgroi, D., & Tuckwell, A. (2021). Evaluating the sunk cost effect. Journal of Economic Behavior & Organization, 186, 318–327.
Stanovich, K. E., & West, R. F. (2008). On the Relative Independence of Thinking Biases and Cognitive Ability. Journal of Personality and Social Psychology, 94(4), 672–695.
Toplak, M. E., West, R. F., & Stanovich, K. E. (2011). The Cognitive Reflection Test as a predictor of performance on heuristics-and-biases tasks. Mem Cogn, 39(7), 1275–1289.
