Later On

A blog written for those whose interests more or less match mine.

Another look at the sunk-cost fallacy

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Sunk-cost fallacy is roughly equivalent to throwing good money after bad. James Surowiecki has a good column in the New Yorker that examines it in a football context:

After a farcical 2012 season, in which the New York Jets invented ever new ways to lose games (thus the “butt fumble”), the team’s general manager, offensive coördinator, and quarterback coach are all gone. Yet Mark Sanchez, the starting quarterback, remains. He has played poorly for two seasons in a row, and has now thrown more interceptions in his career than touchdowns. But the Jets have invested an enormous amount of energy and money in Sanchez, and, assuming that no one will trade for him, they are contracted to pay him $8.25 million next year, whether he plays or not. So figuring out what to do with Sanchez will be trickier than you might think.

The Jets have stumbled into a classic economic dilemma, known as the sunk-cost effect. In a purely rational world, Sanchez’s guaranteed salary would be irrelevant to the decision of whether or not to start him (since the Jets have to pay it either way). But in the real world sunk costs are hard to ignore. Hal Arkes, a psychologist at Ohio State University who has spent much of his career studying the subject, explains, “Abandoning a project that you’ve invested a lot in feels like you’ve wasted everything, and waste is something we’re told to avoid.” This means that we often end up sticking with something when we’d be better off cutting our losses—sitting through a bad movie, say, just because we’ve paid for the ticket. In business and government, the effect pushes people to throw good money after bad. The quintessential case of this is the Concorde. There was never a convincing business case for the supersonic airliner, and there were numerous attempts to kill it. But those attempts all failed, in large part because of the billions that had already been spent.

The sunk-cost dilemma isn’t just about waste. It’s also about reputation—after all, the future is uncertain, and if you keep a foundering project alive there’s always a chance that it will right itself. “Giving up on a project, though, means that somebody has to admit that he shouldn’t have done it in the first place,” Arkes says. “And there are lots of executives who would rather be tortured than admit that they’re wrong.” If you’re faced with this problem, it’s tempting to look to those times when staying the course has worked out. After all, plenty of N.F.L. teams have eventually been rewarded for sticking with struggling quarterbacks—most notably, the Giants with Eli Manning. Andrew Brandt, a former N.F.L. executive who’s now a business analyst for ESPN NFL, told me, “When you stray from decisions from year to year, that’s when you get in trouble, unless you have an option so attractive that it’s worth giving up on your current plan.” The problem is that patience is often simply self-justification. The organizational behaviorist Barry Staw, in a 1995 study of the N.B.A., showed that high draft picks consistently got more playing time than lower draft picks, regardless of whether their performance justified it. When executives think they’re being patient, they’re often just being obstinate.

The most intriguing aspect of sunk costs, as Arkes and others have documented, is . . .

Continue reading.

Written by LeisureGuy

17 January 2013 at 3:00 pm

Posted in Business, Daily life

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