You’ve invested time and money into a rebranding strategy for your ecommerce business, but your online store’s sales are still declining. If you decide to continue pursuing the rebranding strategy because of how much you put into it, despite evidence that it’s not working, you’re giving in to a psychological trap called the sunk cost fallacy.
Learn more about some of the psychological factors that feed into the sunk cost fallacy and strategies to avoid making this mistake in your own decisions.
What is the sunk cost fallacy?
The sunk cost fallacy is a phenomenon in which a person or group is unwilling to abandon a disadvantageous course of action because of past investments. “Sunk cost” refers to past investments of time, energy, and money—all resources that cannot be recovered in the future.
Sunk cost fallacy occurs when a person decides to continue actions because of past costs, even when the present and future costs exceed the potential benefits. The sunk cost fallacy works against rational decision-making in human decision processes, affecting everything from economic behavior to organizational behavior. The sunk cost fallacy can even affect small daily decisions like finishing a boring movie because of the time already spent watching it.
Examples of sunk costs
Here are a few examples of the sunk cost fallacy:
Financial investments
Projects and decisions that require a greater initial investment can lead to the sunk cost fallacy. For example, a marketing manager who made a large initial investment in a paid advertising campaign could be more likely to stick with that campaign, even if the results fall short of expectations. This phenomenon relates to the common phrase “throwing good money after bad,” meaning that the sunk cost fallacy can cause people to spend even more money on poor investments in hopes that the results will improve.
Projects
The sunk cost effect also applies to the amount of time, hard work, and emotional energy that goes into projects. For example, merchants who’ve invested heavily in the development of a new product line could be more likely to continue investing in that project even if there’s negative customer feedback. Decision-makers overseeing new projects need to track current costs and benefits without letting past decisions about project priorities influence future decisions.
Overhead expenses
Another area of sunk costs that can affect business decisions is overhead costs like utilities, insurance, and office supplies. If you’ve invested money and effort in overhead for your business, you can never recover these expenses. Business owners need to regularly consider if their overhead expenses are actually benefiting their businesses. For example, a merchant could mistakenly choose to keep a brick-and-mortar retail store open even when sales aren’t high enough to justify the cost of rent.
Psychological factors behind the sunk cost fallacy
When identifying the sunk cost fallacy in decision-making, it’s important to understand some of the psychological factors that contribute to it:
Commitment bias
Commitment bias, also known as escalation of commitment, is a behavior pattern defined by the tendency for people and organizations to prefer following through on what they’ve previously done or said they would do. For example, someone several years into a sales career could feel a personal responsibility to stick with the job rather than choose a more rewarding career path.
This bias can become even stronger if commitments are made publicly. For example, a business owner who announces a new customer relationship management system to increase productivity for the sales and customer-service teams could feel inclined to keep that system in place even if it’s not a good fit.
Loss aversion
Loss aversion is an emotional bias for minimizing losses rather than maximizing gains. Humans tend to give the negativity of losing something more weight than the positivity of gaining something of equivalent or even greater value.
Loss aversion contributes to the sunk cost fallacy by increasing the focus on how to minimize losses from a previous commitment rather than evaluating the opportunity cost—meaning the missed value, benefit, or profit from other options. For example, an investor could hold on to stocks that have lost value in the hope they recover, rather than sell those stocks at a loss and use the money to invest in other stocks with more promise for future growth.
Framing effect
With this cognitive bias, the positive or negative framing of a situation dictates decisions. This bias plays out when a negative frame is placed on the idea of abandoning an unprofitable previous investment or course of action. A more rational perspective would be to place a negative frame on how unprofitable that investment or action has been and therefore how positive it would be to get rid of it. The framing effect creates a narrative that distracts from the real data about the future costs and benefits of a particular course of action.
How to avoid the sunk cost fallacy?
Here are a few ways you can avoid falling victim to the sunk cost fallacy in your decision-making:
Set clear goals
Write out actionable goals for the outcomes of a new course of action. Establishing clear guidelines for what a success or failure would look like for a particular plan gives you something tangible to reference when making a rational choice about whether to continue that plan.
Irrational decisions can occur when decision-makerslose sight of what success looks like for a project. Use goal-setting tools like software, applications, or physical resources designed to help you set goals and measure their outcomes. Use the SMART goal system to resist the sunk cost fallacy by setting specific, measurable, attainable, relevant, and time-bound goals.
Prioritize data
One of the best ways to make rational decisions is to rely on data for an accurate analysis of costs and benefits. For example, an ecommerce merchant could use Shopify’s reporting and analytics tools to determine if a marketing strategy they’ve invested in is failing to generate enough sales conversions. Making sure you have a good data management system in place can give you the information necessary to avoid the sunk cost fallacy.
Set key performance indicators (KPIs) to gauge how well a certain campaign, strategy, or plan is going for your business. For example, you could evaluate if the click-through rate (CTR) your store receives from an email marketing campaign justifies continuing it. Use as much relevant data as possible when it comes to making decisions about whether to pursue a course of action you’ve invested in.
Stay diligent
Self-awareness can help avert the sunk cost fallacy. Ask yourself if past decisions are still worth the current costs and benefits. Develop a rational decision-making process informed by data and set regular checkpoints to reevaluate. Don’t be afraid to cut your losses if you conclude that current costs outweigh future benefits; find the courage to step away from a previous investment without letting yourself feel emotional or guilty about it. Actively check in with yourself to make sure you’re avoiding cognitive or emotional biases like loss aversion or commitment bias. Assess current alternatives to any course of action, and switch to a better one if it exists.
Sunk cost fallacy FAQ
What is an example of the sunk cost fallacy?
A famous real-world example of sunk cost fallacy is a supersonic aircraft called the Concorde, which the British and French governments funded for decades during the late 20th century, despite clear indications that the sunk costs of the project outweighed the potential benefits.
Why is it called the sunk cost fallacy?
The term “sunk cost fallacy” refers to costs—resources like time, money, and energy—expended or lost for good. “Fallacy” in this context refers to the mistaken belief that continuing an ill-begotten course of action will lead to a better future outcome, thus justifying the sunk costs.
How do you get out of sunk cost fallacy?
Some of the ways you can get out of the sunk cost fallacy include setting clear goals, prioritizing data to make informed decisions, and staying diligent about identifying personal or group cognitive and emotional biases.
