The Sunk Costs Fallacy

Talent Management

November 11, 2011

by Marshall Goldsmith

Let’s say you buy two $100 tickets to a Broadway play two months in advance. The star is your favorite actress, whom you’ve never seen live onstage. That’s the only reason you’re going. A couple of days before the performance you learn the star is ill and will be replaced by an understudy who has received terrible reviews. Do you write off the $200 in tickets, or do you go anyway, reluctant to throw away the tickets — your sunk cost — justifying the additional costs of getting to the theater and dining in Manhattan.

An economist would say the smarter decision is to stay home. Either way, the $200 has been spent and cannot be recovered, so why worry or build around it decisions that will cost you more money and make you frustrated?

I started paying attention to people’s foolish devotion to sunk costs in the early 1980s when I read historian Barbara Tuchman’s The March of Folly, her superb study of the pervasive presence of what she calls mental standstill in governments. Here’s how she described it:

In its first stage mental standstill fixes the principles and boundaries governing a political problem. In the second stage, when dissonances and failing function begin to appear, the initial principles rigidify. This is when, if wisdom were operative, rethinking a change of course is possible, but they are as rare as rubies in a backyard. Policy founded upon error multiplies. The greater the investment and the more involved in it the sponsor’s ego, the more unacceptable is disengagement.

Her concept explains why when an investment loses half its value, rather than cut our losses and get out, we hang on until the investment is worth practically nothing. We persist because we cannot admit error.

Tuchman’s book opened my eyes to the many forms of standstill — not only mental, but emotional and professional — around me. When my UCLA colleagues would respond defensively, even violently, to well-meaning constructive criticism of their research papers, I saw it as another sign of the sunk cost fallacy. They were so attached to their years of hard researching they couldn’t brook an alternative viewpoint. It was the same when I heard people making excuses for their poor behavior. After living with their dysfunctional behavior for so many years people become invested in defending their dysfunctions rather than changing them.

Sometimes even achieving a desired level of success can be a sunk cost that limits your MOJO. I learned this from my mentor, Paul Hersey. I was 30 years old at the time. I had a Ph.D. in Organizational Behavior and I had fashioned a nice professional life as an expert on customized 360- degree feedback programs and their implementation. My modus operandi wasn’t complicated. Companies would hire me to study their operations and tailor a “three- sixty” just for them. We then designed training and follow-up around these inventory results. It was a very narrow specialty, but I’d sort of invented it, so I could charge a healthy day rate for my time.

Paul Hersey took me aside and said, “Marshall, your problem is you’re making too much money. You’re very successful running around selling days and getting paid. But you’re becoming addicted to this success. At your current pace, all you’ll ever do is run around and sell your days. You’ll have a good life, but you’ll never be what you could be.”

Hersey made me see that I didn’t have the guts to shake up my reliable way of making a living. That would mean taking a risk. It would mean jettisoning some of what I had invested in developing my customized 360s— my sunk cost— and turning to something else. I’m convinced if Paul hadn’t pointed this out, I’d still be doing today what I was doing at 30, the economic value of which has rapidly declined because of the Internet.

After finally listening to Paul’s advice, I began writing and doing research that had no short- term financial reward, but produced huge long- term career benefits. The positive difference long-term was huge.

Take a look around you. Are your decisions based on what you might lose or what you have to gain? If it’s the former, your devotion to sunk costs might be costing you more than you know.