The Sunk Cost Fallacy

Have you ever invested time and energy into something, and then realized that the disadvantages associated with the decision are more than the advantages but still follow through with the decision? That is called a ‘Sunk Cost Fallacy’

Before understanding the sunk cost fallacy, we must understand what a sunk cost is. A sunk cost is the money that has already been spent and cannot be recovered. A sunk cost should not be used to influence future business decisions, the way a future cost does, because it is irrational. For example, a pharmaceutical company invests money in research and development of a new drug, but due to side effects, the drug is no longer recommended by doctors. The money invested into the new drug is the sunk cost for the pharmaceutical company and should not be used to influence future decisions.

The Sunk Cost Fallacy is the tendency of individuals to continue an activity they have heavily invested in (could be in the form of time, money, energy, etc.) even when giving up is the better outcome. This is a behavioral economics concept that affects decision-making in businesses, governments, policymaking, and many other areas of life.

The Sunk Cost Fallacy affects a business in terms of creating and selling a product. It is difficult for a businessman to back out of a project, especially when they have put an immense amount of time, energy, and effort into the project. The rule of sunk cost fallacy will come into play when a businessman decides to continue with a project despite knowing that it will be more profitable to the business to give up on the project rather than continue working on it. For a business to be able to create successful products, it must be aware of the sunk cost fallacy. The decision-makers in a business must be able to recognize when a project isn't going as planned and discontinue the production of the project, irrespective of the amount of time, energy, and effort invested into it. 

The Sunk Cost Fallacy occurs because of irrationality in decision-making and emotions of regret and guilt if we do not follow through with a decision. The psychological factors that cause the sunk cost fallacy are loss aversion and commitment bias. Loss aversion is when an individual prefers to avoid a loss over an equivalent gain. Individuals may feel they will lose their investment if they do not follow through with a decision, rather than reaping the benefits if they do not follow through with the decision. Commitment bias is when an individual sticks to a plan because that is the original that they made. This means that an individual continues to support their past decision despite knowing it isn't the best course of action.

The only way to overcome the sunk cost fallacy is to not fixate on emotions of guilt and regret that fill an individual for not following through with a decision and focus on the current and future costs and benefits associated with not following through with a decision. We must not let our emotions influence us when we are making a particular decision and make decisions with a rational mind.