The sunk cost fallacy

Imagine you have already bought a ticket to a movie, but on the way to the cinema you find out that the movie you are going to see is pretty average and there is a great movie showing at the same time. What do you do? Lots of us would see the average movie because we had already bought the ticket rather than paying for a second ticket to see the great movie.

Now imagine that you arrive at the cinema without having bought a ticket and find that they are showing the average movie for free, or you could buy a ticket for the great movie. In that situation we are much more inclined to pay to see the great movie.

But economists would tell us that we should treat both situations the same way – the cost of the movie ticket we have already bought in the first scenario is a sunk cost. We can’t get that money back, but we generally give it too much emphasis.

It’s called the sunk cost fallacy, and it shows up everywhere.

I kept my business coaching business going three years longer than I should have. Three years before I finally killed it, I knew it wasn’t working, things with my business partner were deteriorating, and in my heart I knew I wasn’t happy and it was time to move on.

But I’d invested seven years of my life into it and I couldn’t just throw that away. So I waited another three years to make that difficult decision (and haven’t looked back since).

Friends of ours are moving overseas for three years and were deciding which of their two cars to sell, and which to keep. They have an expensive car, and a really expensive car, both of which they bought new about a year ago. They were going to keep the really expensive car because that had dropped the most in value since they bought it (in other words, that one had cost them the most in depreciation). But that’s the wrong way to look at it – the depreciation they have already suffered is the sunk cost. They needed to look at which one was going to cost them more over the next three years while they were away.

The sunk cost fallacy often stops us from killing projects when the right thing to do is to take them out the back and put them out of their misery. When we evaluate a project or a part of our business, or even the business itself, we need to look to the future, not the past. How much will it cost in the future (in terms of time, money, effort etc) and what will the return on that be. If that equation doesn’t look good, it doesn’t matter how much has already gone into it, it’s time to let it go.

Aiming to fail 50% of our projects is one little trick that helps make it easier to overcome the sunk cost fallacy, and to let projects go when their time is up.

Love to hear your thoughts – how have you let your sunk costs influence your decisions when you shouldn’t have? You can leave your thoughts below.