Imagine that you bought a $100 ticket to a ski resort in Michigan.
A few days later, you find a $50 deal for a ski resort in Wisconsin.
The $50 Wisconsin deal promises better ski slopes, nicer snow, and an all-around more fun experience.
On impulse, you buy that ticket, too.
Then you learn that the two ski tickets are valid only on the same day. Bummer!
The tickets are non-refundable and non-transferrable.
Other costs are equal: you’ll spend the same money and time traveling to Michigan or Wisconsin.
Imagine that you have no emotional connection to either state. No family or friends live there.
You’re faced with a certain loss: you have to sacrifice either the $100 Michigan ticket or the $50 Wisconsin ticket.
Which one would you choose?
Researchers Hal Arkes and Catherine Blumer posed this question to a team of research subjects. The majority said they’d sacrifice the $50 Wisconsin ticket, even though it promised the more fun experience.
Why?
Loss aversion. Most people prefer to minimize their losses, even if it means enduring a sub-par experience.
This is known as the “sunk cost fallacy.”
People reflect thinking along the lines this fallacy when they say, “Well, I’ve already sunk this much money/time into it. I can’t stop now.”
Would You Spend Your Last Million on a Plane?
The same researchers divided people into two groups. They posed this question to Group A:
Imagine that you’re the president of an airline company. You have a $10 million research budget. You decide to spend that money building an airplane that can’t be radar-detected.
You spend $9 million developing this plane. Before you’re finished, a competitor unveils its undetectable plane. Your competitor’s plane is faster, cheaper, stronger and better than yours.
Would you spend the last $1 million finishing out the development of your airplane?
The researchers then posed the following question to Group B:
You’re the president of an airline company. You have only $1 million left in your research budget. Someone suggests that you put that $1 million towards the development of an airplane that can’t be radar-detected.
However, you know that your competitor just released such a plane. You also know that your competitor’s plane is faster, cheaper, stronger and better than a plane you could create. Would you do it?
The scenario is the same; sunk cost is the only variable between Groups A and B. How did the two groups respond?
The vast majority of Group A – a whopping 80 percent — said yes, spend your last $1 million finishing the airplane. Less than 10 percent of Group B agreed.
Would You Get Stuck in Snow to Justify Your $12 Ticket?
Imagine this scenario:
A man wins one free baseball ticket from a radio show. He doesn’t want to attend the game alone, so he convinces his friend to buy a $12 ticket to accompany him.
On the day of the baseball game, there’s a freak springtime blizzard.
The man who won the free ticket says, “I don’t want go drive in this snow. I’m not going to the game.”
His friend, however, protests, “I don’t want to waste the $12 I paid for the ticket! I want to go!”
“The friend who purchased the ticket is not behaving rationally,” say Arkes and Blumer.
“The $12 has been paid whether one goes or not … It should in no way influence the decision to go.”
“Only incremental costs should influence decisions, not sunk costs. But who among us is so rational?”
Would You Throw Good Money After Bad?
A hungry lion crouches near a herd of zebras. He’s been waiting for more than an hour, hoping to catch his next meal.
The lion realizes he won’t catch one of these zebras. They’re too far away. They can outrun him.
Does the lion think, “Gee, I’ve already been waiting for an hour. I may as well stick around?” No, of course not.
As soon as the lion figures out that he won’t catch dinner, he leaves.
Humans are unique.
We throw good money after bad.
- We hang onto investments that we know are losers, in an effort to “see if I can break even.”
- We linger in careers that make us unhappy, since we “already put ten years into this industry.”
- We heap an additional debt onto our credit cards, since “I’m in so much debt, an extra $200 won’t matter.”
- We force ourselves to finish reading a boring book, just because “I’m already halfway through.”
The Bottom Line: Consider the sunk cost fallacy the next time you find yourself lingering in a job you don’t like, holding an investment long after the financials justify keeping it, or forcing yourself to finish a project just because you’ve started it.
The time and money you’ve sunk is irrelevant. Don’t throw good money after bad.
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Money Beagle
With the plane, you might have a situation where you could sell the protoype/technology to someone who wouldn’t care that it was slower, etc. Even if you sold it at a loss, if you got more than $1mm for it, then it would be worth it to put the last million in, assuming you got zero if you just stopped once you found out about your competitor.
You’re definitely right that sunk cost plays too big a role, but sometimes you have to look at other variables that come into play.
Anne @ Unique Gifter
Yes, further to Money Beagle’s point. Most decisions of rationality addressed in economics use the “all else equal” principle when looking at sunk costs. Reality is dreadfully more complicated. *sigh* Basic assumptions state that people are rational actors, but they are not; we encounter the same problem with collective rationality and individual rationality not being the same…. game theory… etc.
Sorry, I econ’d out there for a second. 🙂
You do make a valid point, yet most of the examples were treated ceteris paribus, which tends not to actually exist.
Edward
I believe I learned this early on in life. Whether it’s a project, a relationship, an event, a posession, or an investment, if I ask myself, “Is this a piece of cr@p?,” and have to honestly answer “Yes,” then it’s time to unload it. …Chuck it, start over, whatever. Nothing is sacred.
AffordAnything.org
@Edward — I like that mentality (and I like that question that you pose to yourself!)
Dave @ 6400 Personal Finance
The Army term for this would be to know when to “cut slingload” on something. Imagine a helicopter flying over the mountains of Afghanistan with a resupply payload slung below it. Just a few miles from the objective insurgents light up the sky with a wall of anti-aircraft fire. The pilots face a choice: try to fly through the fire and almost certainly get shot down (and create a second set of soldiers on the ground in need of help) or drop the payload to gain maneuverability and retreat to try again at a different time. The rational option is to “cut slingload” and get the hell out of Dodge.
I’m with you Paula. Contrary to the opinions of the above commenters not only is your principle sound but so was its application in the examples you gave. Getting lost in an infinite sea of qualifiers is a sure way to end up doing nothing and losing money through inaction.
Matt @ Air Charter Service News
Dave thats a great analogy, in this case the cost of falling to your death/capture outweighs the cost of losing the payload short term. Great article by the way.
Joe Ellison
Great article. I enjoyed spending some time reading it. I’ll bookmark your blog to visit again from time to time. Keep it up!
Nick Chira
Agreed with above in that the stealth plane example is not ceteris paribus
1) First example implies it’ll take $1 million to finish the plane development, which should be fairly accurate in end of development cycle, 2nd example merely states that you’re putting the first million to development, which implies further development costs. Not to mention just finishing the product will get your name out there as somebody who can actually make a deliverable product rather than just specs.
2) Having spent $9 million implies a large barrier to entry into the market, so it makes more sense to finish developing a product even if it’s inferior in several senses to top competitors.
Kay
Another area where this sunk cost fallacy applies
– I’ve already wrecked my diet for today. whats a few more slices of cake? 🙂
Kurt
I think about the sunk cost fallacy in the context of a bad movie. Say you pay $10 to see a movie at the theater. Within 10 minutes you recognize clearly that you’re going hate the movie. Do you watch anyway because you’ve already spent the ten bucks?
I think most people would stay and watch the movie, but I’d leave. Here’s why:
– if I leave, I’ve wasted $10.
– if I stay, I’ve wasted $10 + 2 hours.
I prefer to waste the least, so I leave.
Paula Pant
@Kurt — I LOVE this comment!!
10,000 thumbs up!
Sathish Chandra
I hope for positive changes. In fact it has worked for me majority of times. Why should I lose hope and quit when there is possibility of positive changes.
let’s say, even till end there is no positive changes, but if you start listing out the good points we can still get some even in a bad movie. Work on those good points and try to learn, then definitely we will be able to get good results from that.
Michael @ NTPNW
I enjoyed this article. I see folks doing this all of the time. Some of my co-workers use this mentality to justify why they continue working in a job they hate instead of moving on to better pastures. I will be back to read more from your blog. Take care.
Ashlee @ SMD!
I think this is a great reminder and explanation of our (non-economist) human nature. It made me think of Dwight from The Office when he says, “Whenever I’m about to do something, I think, ‘Would an idiot do that?’ and if they would, I do not do that thing.”
Maybe we should all remember Dwight when we find ourselves in a sunk cost fallacy.
Well written and interesting article!