What Is a Sunk Cost?
A sunk cost, sometimes called a retrospective cost, refers to an investment already incurred that can’t be recovered. Examples of sunk costs in business include marketing, research, new software installation or equipment, salaries and benefits, or facilities expenses. By comparison, opportunity costs are lost returns from resources that were invested elsewhere.
Economists suggest that, in theory, sunk costs are not relevant to future decision-making. In practice, however, sunk costs can and do significantly influence decisions about the future. This is largely because it’s psychologically challenging to let go of previously invested time, effort, or financial resources even if the outcome of those investments fails to meet expectations.
What Is a Sunk Cost Fallacy?
A sunk cost fallacy is often simplified to the idea of throwing good money after bad while refusing to cut one’s losses.
Jim Semick, Co-Founder of ProductPlan, explains it this way:
“In sunk cost theory, we will often decide to stay with something because we’ve put time or resources into it. We believe that because we have ‘sunk’ that cost into it, we somehow need to recoup it. That’s a fallacy.”
A study conducted in 1985 by Hal Arkes and Catherine Blumer, behavioral economics researchers, found that “people’s decision-making varies depending on how much time and resources they have already invested in the matter.” Blumer and Arkes distilled the sunk cost mindset as “a greater tendency to continue an endeavor once an investment in money, effort or time has been made,” despite its irrationality.
According to the Decision Lab, a behavioral-science-based research firm focused on improving decision-making, “the sunk cost fallacy occurs because our emotions often cause us to deviate from rational decisions. For example, abandoning an endeavor after committing to it and investing resources into it will likely cause negative feelings of guilt and wastefulness. Since we want to avoid negative feelings of loss, we are likely to follow through on a decision that we have invested in even if it is not in our best interest.”
How Does This Cost Impact Product Management?
For product managers, sunk cost fallacy can cloud rational thinking. PMs are naturally passionate about their initiatives. Evangelizing a new feature or product and motivating others around them are central to the PM role. Unsurprisingly, recognizing that a feature or product is no longer achieving its objectives after investing considerable time, energy, and resources can be challenging.
Understanding the underlying psychology of the sunk cost mindset can shed light on why it’s so difficult to let go.
What Factors Lead to the Sunk Cost Fallacy in Decision-Making?
Here are 5 factors that can lead to the sunk cost fallacy in decision-making:
- Loss aversion: Preference and tendency to avoid loss over an equivalent gain
- Framing: Cognitive bias to avoid risk with a positive frame and accept risk with a negative frame
- Overoptimistic probability bias: Perception that cost increases future return on investment
- Personal responsibility: Connecting the investment and effort with an individual or group directly involved
- Wasteful: A desire to avoid being judged as having wasted time, resources, or cost investment in an effort
Read these tips for letting go of an initiative when it no longer works for you.
How to Avoid Sunk Cost Fallacy in Decision-Making
Here are a few strategies to manage the uncertainty of whether to continue developing a new feature or product or put it to rest to invest resources and time in a project that might yield better results:
- Understand the desired outcome (What is the goal you want customers to achieve? Are there alternatives?)
- Revisit prioritization (Are you working on the right things?)
- Focus on the next few sprints (Look at the big picture in broad terms, but keep detailed planning for the immediate future.)
- Embrace uncertainty (Success is more likely to follow when you are open to change and opportunities.)
- Don’t take it personally (Smart decision-making centers product vision and strategy, not the decision-maker.)
See Also: Weighted Scoring, Opportunity Scoring, Backlog, Prioritization, Sprint, Business Agility.