How many of us find it difficult to let go of a project even when it’s clear that there are better uses of our incremental time and effort, simply because we feel the time and energy already invested will be wasted. That time and effort already invested is sunk cost, a critical concept in management decision making. This piece in the HBR by Professor David Ronayne highlights a study by himself and his colleagues which shows how prevalent this issue is and how organisations can tackle this.
“The effect is often attributed to well-known high-stakes decisions across various contexts. For example, the management at General Motors’ reluctance to move away from once-winning strategies is said to have contributed to the firm’s decline late in the last century. In aviation, throwing good money after bad is generally considered to have led to the massive investment by the British and French governments in the Concorde project (indeed, the sunk cost effect is still sometimes referred to as the Concorde Fallacy). And in the political sphere, examples such as the prolonged U.S. military campaigns in Vietnam and Iraq suggest that the effect can lead not only to financial ruin, but also to the loss of tens of thousands of lives.
It is a core lesson in many business economics or decision-making classes that any unrecoverable costs sunk in the past are irrelevant when deciding what to do next. Decision-makers need to remember: when sunk costs affect strategic decisions, there can be real and dire consequences.”
He then goes on to explain the study which shows the prevalence of the sunk cost fallacy and then highlights why experience based wisdom more than raw intelligence can help overcome this:
“Our work also sheds light on the drivers of susceptibility to the sunk cost effect. Our respondents completed psychological tests providing various measures of cognitive ability. We found that experience or stocks of knowledge (so called “crystallized intelligence”), rather than raw computational power (“fluid intelligence”), enable one to avoid falling prey to the effect: in other words, being wise may count more than being smart.
This is consistent with the general theory that to avoid decision-making biases, you need the ability to recognize the fact that you’re facing a situation in which you should override your instincts or heuristics. In contrast, the brute force brainpower needed to avoid the sunk cost effect once you realize you face it, is relatively slight.
However, if seasoned decision-makers at the top of large firms and governments succumb to the effect it shows that although experience may help, it is not sufficient to override important biases such as the sunk cost effect. Your own experience may have made you wise to some traps, but regardless of your seniority, by choosing what you would do in the scenarios of the SCE-8 you will get a sense of how susceptible you are, and with that in mind, empower yourself to make better decisions in the future.”
If you want to read our other published material, please visit https://marcellus.in/blog/
Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.
Copyright © 2022 Marcellus Investment Managers Pvt Ltd, All rights reserved.