In the National Basketball Association (NBA), teams frequently offer players multi-year contracts, based on performance or potential. However, various factors like aging or injuries can lead to a decline in these players’ performance over time. In some cases, despite the initial promise, these players may not meet expectations. They are a sunk cost. Despite this, teams may still prioritise the player. They get more game time although there are more productive players on the team. The coach must now decide whether to succumb to the sunk cost fallacy or focus on other players.
Let failing projects fail
In accounting terms, a sunk cost is a result of a past decision. There is nothing we can now do about it. Sunk cost is always irrelevant to future decisions and we should ignore it in any investment analysis. There is no room for sunk cost in a business case.
It is human tendency to continue to invest in an endeavour once money or time have been committed, regardless of the future benefits. “I’ve spent this much or worked this hard; I can’t give up now”. A project is failing, but we pour in more resources because of the substantial amount already invested. An employee may keep using an outdated system or process because of the time they’ve spent learning it. More efficient alternatives could be available.
Avoid the Sunk Cost Fallacy
To avoid this fallacy, one must analyse future investments based purely on future costs and benefits, not past ones. Analyse the current state and adopt strategies based around rational thinking to avoid the pitfalls of a sunk cost fallacy. People only consider sunk costs because they don’t want to admit that they have wasted a lot of money and should stop the project. The only way to avoid the sunk cost fallacy is to face brutal reality.
Six Thinking Hats
One method of doing this is through the Six Thinking Hats. I remember my primary school teacher doing this as a classroom exercise many years ago. It can also be a useful thinking process tool for adults when it comes to solving complex situations or challenges. Thinking laterally separates logic and emotion and encourages managers or decision makers to look at a problem from different perspectives. Below is a diagram of the Six hats and what each colour represents.
We use the six thinking hats to force people to view issues and decisions from a different perspective than is typical for each person. The person who is often most critical may don the yellow hat and identify positive aspects. The person who reacts with feelings may don the white hat which requires them to take a rational, data-based approach. This technique helps team members understand different perspectives. Six Hats improves communication skills, presents different ways of thinking and encourages people to be more supportive of their colleagues. Most importantly, it breaks people out of the paradigms they normally use to make decisions.
Overall, the sunk cost fallacy is like an NBA player who costs vast sums of money but is no longer competitive. That player may have performed well in the past. You now need to invest in new players who are the future of the team. By understanding and addressing our biases, people and organisations can make more effective decisions.
Remember, what’s spent is spent. The key is to look ahead, not back.