The sunk cost fallacy or why rational people make irrational choices

'Sunk cost' is a term describing an expense that cannot be recovered. The 'sunk cost fallacy' is the tendency toward keeping the commitment to an activity because we have already invested some kind of resource in it, regardless of the fact that this activity could increase our losses. It is the scientific name for the popular expression "throw good money after bad".

Let's imagine you are going to this ultra expensive French restaurant to have a diner on your special occasion. And you are told that they have the most delicious dessert on the Planet that you must try. Sure it has a ton of sugar and like a billion of calories, it is the unhealthiest meal ever and it will ruin your diet let alone your past week in gym. But it's worth it, they say. And there you go - you order the famous thing, parting with a large amount of your hard earned money. You are ready to taste it. You take a piece, bring it to your mouth and then... And then it turns out that it is just plain awful. And you start calling names this idiot that recommended it to you. But what happens next...

The logical thing is to throw the desert away. There is no use of it - why ruin your diet after you've already spent a fortune on it? Why don't you just cut the losses and move on? It is the logical thing to do. But we are not logical creatures, are we? More often than not, we are emotional creatures.

Let's look what happens on the emotional side.

You feel guilty. You just spent a big amount of money on the damn thing, you can't just get rid of it, besides - your momma told you not to throw away food. Can you imagine the people in Africa starving to death? So how do you ease your guilt?  That’s right - you eat it, although it is not the best thing to do.

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Or let's imagine that you are a manager in an organization and sponsor of an extremely costly project. You feel like the most important person in the world. But the project doesn't go so well, to say the least. It is very close to the initial deadline, but the project is nowhere near its first milestone. The budget is already spent. You will need a big amount of extra money to continue. And on top of it - the initial reason for starting the project has changed so it is questionable if this project is still relevant.

The logical thing is to reassess the situation and ultimately - to stop the project, cutting the losses.

But what the emotions say to you? Maybe they are telling you that if you stop the project, you will look like a fool in your employees' eyes. What about your superiors? And all your friends you brag about?

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These are just examples of course, to make my point. Usually the case is not so clear.

Psychologists suggest that the reason to continue could be the hope that the things will change for the better: What if the desert's taste starts to feel different after the first bite? Maybe your senses need some time to appraise the French gourmet's delicacy. And maybe that project's turning around is just behind the corner. And it will prove to be a big success.

The fallacy is that we tend to overestimate the reasons to continue, while underestimating the reasons not to.

  

I've been in the trap of the 'sunk cost fallacy' a lot of times. And also have seen this in the business and in other people decision making too.

I believe that in order to overcome the fallacy you:

            1. Have to be aware of it. Take a look at the situation, see what is going on.

            2. Be aware of the underlying emotions. Are they obscuring your mind? Are they causing you to make irrational choices? What is your motivation? Do you continue the project because it will benefit the organization or because you want to save face?

Makes sense? I hope it does.

Simplicity as a business model

"A variety of colors makes man's eye blind; a diversity of sounds makes man's ear deaf; a mixture of flavors makes man's palate dull."  Lao Tzu

Do you know what 'halo effect' is? It is psychological bias. According to Wikipedia: "the halo effect refers to a cognitive bias whereby the perception of a particular trait is influenced by the perception of the former traits in a sequence of interpretations."

Furthermore:

"In brand marketing, a halo effect is one where the perceived positive features of a particular item extend to a broader brand. It has been used to describe how the iPod has had positive effects on perceptions of Apple's other products."

Well, in a way iPod increased dramatically the interest for Apple's as a company, hence - their product's popularity. But I don't think this is the key to Apple's success. It is not the root cause - it is just an outcome of their brilliant strategy.

It is clear that quality is an essential ingredient of their recipe for success, but what I'm really interested in is: How they manage to establish a perception of exclusivity and uniqueness for everything they produce?

And the answer is: they make only 'halo' products. Simple and effective.

Take a look at the PC or mobile phones market for example - you can choose from hundreds of models which differ in every possible way. It is extremely difficult to be eminent in a market characterized with excessive variety.

But Apple doesn’t produce PCs or mobile phones. They produce Mac and iPhone. They define their own market, which motto is: 'we don't need to make hundred models, we make just ONE and we put our BEST effort in it; we make it one, but we make it count'. Does this strategy work? You tell me.

Simple and effective. It yields the coolness aura of Apple’s products.  And gives them the edge over ‘the others’. The zen way of doing business.