Sunk Cost Fallacy

The great thing about society is that even though every one of us differs in one way or another, we still have certain psychological tendencies we fall for. These cognitive biases tend to rule our everyday thinking whether we know it or not. It doesn’t matter what industry you work in or what your background is like – we all share these tendencies. One such tendency is known as the ‘Sunk Cost Fallacy’.

Picture yourself buying a ticket for a movie you’ve been eager to see. You checked out the ratings and they’re decent, not spectacular. Then, you get to your seat and the movie begins. However, you realize about 30 minutes in that the movie is terrible and that you can’t stand being there any longer. But then you remember that you paid for the ticket and you can’t get a refund for it. The rational decision here would be to cut your losses and get out of the movie theater before you waste another second. Humans aren’t always rational though, so you decide to watch the whole movie and complain all the way home.

This perfectly describes the concept behind the Sunk Cost Fallacy. There’s a cost that has already been deducted and that cost can’t be recovered. Even though this investment turned out terribly, you wait out and hope that the movie improves over time, which rarely happens. Now replace this with other scenarios and you’ll understand why this is such a universal occurrence – eating the entire plate of food at a restaurant when you’re already full or continuing to date someone you’re not compatible with. People don’t usually know when to cut their losses; they base their current choices on past mistakes.

In the financial world, especially in venture funding, the Sunk Cost Fallacy can mean the death of a firm. When an investment initially seems like it might be a home run, but the startup begins to go south, the irrational thing to do is to put more money behind it. This is known as “throwing good money after bad” and usually results in a worse return than cutting your losses. It’s one of the worst things you can do as an investor, almost like a cardinal sin. To fix this, you need to be disciplined, unbiased, and you may need the perspectives of several others so you don’t get in your own way. Don’t base these decisions on past mistakes and cut out the investments that aren’t working.

As a startup SCF can be similar to not knowing when to pivot. If you’re working on what you think is a great solution for a problem, but the market thinks otherwise, you need to stop what you’re doing and immediately think about your next steps. A lot of the times, founders become emotionally rather than financially invested and that’s what can hold them back. By being objective and simply looking at the signs, the decision usually becomes more clear. Knowing when to pivot is just as critical to a startup as the product itself since time is your most valuable asset, though it’s usually not on your side.

Sunk Cost Fallacy is harder to overcome than it seems. It wouldn’t be a common cognitive bias if it wasn’t. By taking emotions out of the decision-making process and focusing on the objective side of things, it does get a little easier. Just because you’ve already invested in something that didn’t pan out doesn’t mean you show throw more into it. Don’t let past mistakes influence your current choices. So next time you go to a terrible movie or can’t finish your plate, just leave it and call it a day.