Psychology

SUNK COST EFFECT

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We want to make rational decisions, and if they are not, we want to believe otherwise. It turns out that rationality often loses out attachment to the effort made. We don’t want it to be fruitless. Thus, we fall into the trap of sunk costs (also called the sunk cost effect or the Concorde effect), i.e., the tendency to persist in a decision we have made, even when it is unfavorable because it involved significant effort or high costs.

WHAT ARE SUNK COST?

Normative economic theory teaches that sunk costs are those that have already been incurred and cannot be recovered. So when making decisions, we should reject them and focus only on future benefits. Time and money spent on anything cease to matter once it is spent. A good economist is guided by the slogan, “The rest of your life begins now.” Real choices, even for economists, however, deviate from the ideal pattern. We behave irrationally by ignoring the available alternatives.

LIFE EXAMPLE

Imagine this situation. You’re planning to go to the movies. The ticket has already been bought. You hardly got it (no matter how). It wasn’t cheap. Spoilers had to cost a fortune – like a ticket. It promises to be a great evening with an exciting, action-packed, and suspenseful performance. The world cast seems to confirm this. An hour before you leave, you talk to a friend. He had already watched the movie. In his opinion, you doom yourself to 3 hours of boredom. The plot is straightforward (nothing will surprise you), the acting is weak, although it is not science-fiction, it is full of absurdities, and the special effects are as if they were made by the author of this blog. You also know that your friend knows you very well and you can trust him. However, you go to the movie and find out that it wasn’t worth it. Even though you were bored, you didn’t leave before the movie ended.

What was the motive behind this action?

The thing is, the ticket really was expensive and it was a shame for it to go to waste. This means that by being in this situation and acting this way, you are falling into the trap of sunk costs. It would be too painful to think about throwing your hard-earned money down the drain.

COMPENSATION

If money has already been spent, it would still be more sensible to plan your time differently. Similarly, investments should be approached rationally. It is not uncommon for them to be planned well in advance, and at the time of implementation it turns out that for various reasons it will not be profitable. We have a tendency, whether as people or as an organization (companies, governments) to want to recover lost costs. Often the only way to do this is to continue a given activity, even if it brings increasing losses or exposes to such losses.

Such action is quite characteristic of the early days of gambling. The desire to compensate for losses leads to playing for larger and larger amounts in the hope of gaining more profit and covering losses. Too late reflection may lead to gambling, where the aim is no longer to recover losses, but most often gambling for the sake of gambling.

INVOLVEMENT

The more difficult the process led to the goal the more valued that goal is and the more committed we are to it. For example, social psychologists E. Aronson and J. Milles studied the impact of initiation before joining the group on the evaluation of its attractiveness. It turned out that people who underwent a boring and, one might say, meaningless initiation rated the attractiveness of the group they joined more favorably than people without initiation. In the experiments of H. Gerald and G. Mathewson the participants who were electrocuted expressed warmer opinions about the target group.

The same is true for evaluating your career performance depending on the complexity of the hiring process. Once you’ve gone through the hard way, you’ll be more pained to change jobs, especially to one that’s easier to get into. Given that some hiring processes tell you as much about an employee as their day-to-day disposition, the essential purpose of hiring is precisely engagement. I myself was interviewed many years ago as one of a dozen candidates scheduled at 20-minute intervals, except that…. I didn’t see anyone but me.

JUSTIFICATION OF DECISIONS

As mentioned, we like to be rational, or at least believe that we make rational decisions. We can compensate for the resulting cognitive dissonance between the belief: “I am a rational person” and “the movie will be boring”. In this situation, the theory of cognitive dissonance says that we can convince ourselves that the movie will not be so boring after all, so the decision is rational. In fact, even if the movie turns out to be boring, we can still say that it was not that bad. We do it just to make ourselves feel better.

LACK OF DECISION-MAKING

Passivity comes much easier than making decisions. If the decision made is connected with inevitable regret for the loss (of money, time, anything) we tend to persist in the status quo. Sometimes this is accompanied by hope, sometimes based solely on wishful thinking, that maybe fate will change, something will happen that will make, despite all the signs in heaven and earth, the original decision will turn out to be a hit in “10”. Of course, you can win in the casino after a series of losses, but the chances are really not great. After all, we do not want our lives to be ruled by chance, but to have a real impact on them.

CONCORDE EFFECT?

A commonly presented example of the sunk cost trap is the story of the Concorde supersonic airliner. It was the product of an international agreement between the French and British governments. Its construction began in 1965. The project cost 10 times more than expected and ended up costing around £1.2 billion. It is alleged that it was clear from the design phase that the investment would not be profitable, yet work continued. As a result, only 20 were produced, and after some 30 years of loss-making flights, the aircrafts were grounded. It is worth noting that the project was more political than economic. The British side required in the contract a high penalty for breaking it. In addition, fuel prices rose after the work began. Concorde emitted tremendous noise. After all, it flew faster than a bullet from a gun. Therefore, in some countries and places, its flights were banned. The Concorde crash on July 25, 2000, near Paris grounded the machines. At takeoff, a piece of tire hit the fuel tank and after a while the plane burst into flames, not sparing any of the passengers. Flights resumed 2 months after the September 11, 2001 attacks, a time when confidence in flying, in general, was declining.

While the first commercial orders of a few dozen units were optimistic, they were quickly canceled. Not a single aircraft was sold commercially. However, flights were not always unprofitable. British Airways, after changing its pricing policy, was able to make a clean profit of about 750 million pounds during the year. Unfortunately, this was too little for the investment to pay off, given the costs of the development phase and the early losses (especially on the French side, which stuck to its original assumptions). Perhaps Concorde would have reigned longer in the skies had Airbus not refused further support, and had British Airways agreed to sell the Concorde fleet to Virgin Airways at a discounted price.

Why the question mark in the subtitle?

And this is because the project was not necessarily doomed from the start. Interest in supersonic aircraft during the design phase was not small, and the British were able to make money on them. Initial orders could compensate for the losses. So the chances for success were there, although not great. What is more, the project was not only a profit counted in real money. Such a huge undertaking contributed to technological progress and had a political dimension for the countries involved. The name “Concorde” from French meant consent, as did the English equivalent: “Concord”. Apparently an agreement, but the parties were in dispute over the last letter of the name.

Concorde in the colors of British Airways Corporation

SUMMARY

Driven by emotion, it is not uncommon for us to make irrational decisions. Set on aversion to loss, we fall into a vicious cycle and lose even more. It is too painful for us to lose so far (the more painful the effort), even if we can lose even more. The consequences of such decisions are not only personal. They often determine the fate of hundreds of people, companies, or countries. Therefore, let us not be afraid to make unpopular but thoughtful and wise decisions. What we have lost will not come back. Let us look into the future – we build it, not the past.

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