You’ve invested money and time right into a rebranding strategy to your ecommerce business, but your online store’s sales are still declining. When you resolve to proceed pursuing the rebranding strategy due to how much you set into it, despite evidence that it’s not working, you’re giving in to a psychological trap called the sunk cost fallacy.
What’s the sunk cost fallacy?
The sunk cost fallacy is a phenomenon during which an individual or group is unwilling to desert a disadvantageous plan of action due to past investments. “Sunk cost” refers to past investments of time, energy, and money—all resources that can not be recovered in the longer term.
Sunk cost fallacy occurs when an individual decides to proceed actions due to past costs, even when the current and future costs exceed the potential advantages. The sunk cost fallacy works against rational decision-making in human decision processes, affecting all the pieces from economic behavior to organizational behavior. The sunk cost fallacy may even affect small every day decisions like ending a boring movie due to time already spent watching it.
Examples of sunk costs
Listed below are a couple of examples of the sunk cost fallacy:
Financial investments
Projects and decisions that require a greater initial investment can result in the sunk cost fallacy. For instance, a marketing manager who made a big initial investment in a paid promoting campaign could possibly be more more likely to keep on with that campaign, even when the outcomes fall in need of expectations. This phenomenon pertains to the common phrase “throwing good money after bad,” meaning that the sunk cost fallacy may cause people to spend even more cash on poor investments in hopes that the outcomes will improve.
Projects
The sunk cost effect also applies to the period of time, labor, and emotional energy that goes into projects. For instance, merchants who’ve invested heavily in the event of a brand new product line could possibly be more more likely to proceed investing in that project even when there’s negative customer feedback. Decision-makers overseeing recent projects must track current costs and advantages without letting past decisions about project priorities influence future decisions.
Overhead expenses
One other area of sunk costs that may affect business decisions is overhead costs like utilities, insurance, and office supplies. When you’ve invested money and energy in overhead for your online business, you’ll be able to never recuperate these expenses. Business owners must commonly consider if their overhead expenses are literally benefiting their businesses. For instance, a merchant could mistakenly decide to keep a brick-and-mortar retail store open even when sales aren’t high enough to justify the price of rent.
Psychological aspects behind the sunk cost fallacy
When identifying the sunk cost fallacy in decision-making, it’s essential to know a few of the psychological aspects that contribute to it:
Commitment bias
Commitment bias, also often called escalation of commitment, is a behavior pattern defined by the tendency for people and organizations to prefer following through on what they’ve previously done or said they’d do. For instance, someone several years right into a sales profession could feel a private responsibility to keep on with the job somewhat than select a more rewarding profession path.
This bias can change into even stronger if commitments are made publicly. For instance, a business owner who declares a brand new customer relationship management system to extend productivity for the sales and customer-service teams could feel inclined to maintain that system in place even when it’s not fit.
Loss aversion
Loss aversion is an emotional bias for minimizing losses somewhat than maximizing gains. Humans tend to provide the negativity of losing something more weight than the positivity of gaining something of equivalent and even greater value.
Loss aversion contributes to the sunk cost fallacy by increasing the give attention to find out how to minimize losses from a previous commitment somewhat than evaluating the chance cost—meaning the missed value, profit, or benefit from other options. For instance, an investor could hold on to stocks which have lost value within the hope they recuperate, somewhat than sell those stocks at a loss and use the cash to speculate in other stocks with more promise for future growth.
Framing effect
With this cognitive bias, the positive or negative framing of a situation dictates decisions. This bias plays out when a negative frame is placed on the concept of abandoning an unprofitable previous investment or plan of action. A more rational perspective can be to put a negative frame on how unprofitable that investment or motion has been and subsequently how positive it might be to eliminate it. The framing effect creates a narrative that distracts from the true data concerning the future costs and advantages of a specific plan of action.
Find out how to avoid the sunk cost fallacy?
Listed below are a couple of ways you’ll be able to avoid falling victim to the sunk cost fallacy in your decision-making:
Set clear goals
Write out actionable goals for the outcomes of a brand new plan of action. Establishing clear guidelines for what a hit or failure would appear to be for a specific plan gives you something tangible to reference when making a rational selection about whether to proceed that plan.
Irrational decisions can occur when decision-makerslose sight of what success looks like for a project. Use goal-setting tools like software, applications, or physical resources designed to assist you to set goals and measure their outcomes. Use the SMART goal system to withstand the sunk cost fallacy by setting specific, measurable, attainable, relevant, and time-bound goals.
Prioritize data
Among the finest ways to make rational decisions is to depend on data for an accurate evaluation of costs and advantages. For instance, an ecommerce merchant could use Shopify’s reporting and analytics tools to find out if a marketing strategy they’ve invested in is failing to generate enough sales conversions. Ensuring you’ve data management system in place can offer you the data obligatory to avoid the sunk cost fallacy.
Set key performance indicators (KPIs) to gauge how well a certain campaign, strategy, or plan goes for your online business. For instance, you might evaluate if the click-through rate (CTR) your store receives from an email marketing campaign justifies continuing it. Use as much relevant data as possible in relation to making decisions about whether to pursue a plan of action you’ve invested in.
Stay diligent
Self-awareness will help avert the sunk cost fallacy. Ask yourself if past decisions are still well worth the current costs and advantages. Develop a rational decision-making process informed by data and set regular checkpoints to reevaluate. Don’t be afraid to chop your losses in the event you conclude that current costs outweigh future advantages; find the courage to step away from a previous investment without letting yourself feel emotional or guilty about it. Actively check in with yourself to be certain that you’re avoiding cognitive or emotional biases like loss aversion or commitment bias. Assess current alternatives to any plan of action, and switch to a greater one if it exists.
Sunk cost fallacy FAQ
What’s an example of the sunk cost fallacy?
A famous real-world example of sunk cost fallacy is a supersonic aircraft called the Concorde, which the British and French governments funded for many years throughout the late twentieth century, despite clear indications that the sunk costs of the project outweighed the potential advantages.
Why is it called the sunk cost fallacy?
The term “sunk cost fallacy” refers to costs—resources like time, money, and energy—expended or lost for good. “Fallacy” on this context refers back to the mistaken belief that continuing an ill-begotten plan of action will result in a greater future end result, thus justifying the sunk costs.
How do you get out of sunk cost fallacy?
Among the ways you’ll be able to get out of the sunk cost fallacy include setting clear goals, prioritizing data to make informed decisions, and staying diligent about identifying personal or group cognitive and emotional biases.
