Sunk cost fallacy, sometimes known as the Concorde fallacy, is a cognitive bias that causes people to include non-recoverable past costs in their decision-making process in a way that leads to more losing or suffering.

This irrational line of reasoning is extremely common and is shown to influence people’s decisions in many domains and situations, from economics to everyday decision-making.

As such, it is important to understand the sunk cost fallacy; you’ll be better able to avoid it, and perhaps save yourself from additional, unnecessary losses in the future. In this article, we’ll explain how this fallacy works in more detail, as well as show several examples of it.

Definition

Furthermore, it’s also sometimes referred to as the “Concorde fallacy”. The name comes after a case where the British and French governments continued funding the development of the Concorde passenger airplane even though it was clear that there was no profit to be made.

Why It Occurs

Generally, sunk costs do influence people’s decision-making processes, whether in business or in our everyday lives.

Typically, when someone has made an investment – whether in the form of money, time, or energy – on a particular endeavor, they are more likely to continue with it because they feel that the past investment justifies, or perhaps even requires, them to make further investments on that endeavor.

A major reason for this is the commitment bias, which is a cognitive bias that describes how people tend to stick with their past behaviors, even if fresh evidence were to show that it likely won’t lead to a good outcome.

Additionally, according to the renowned psychologist Daniel Kahneman and Amos Tversky, another factor is the loss aversion effect, or the tendency to prefer avoiding losses more than pursuing equivalent gains.

Why It’s Irrational

According to economists, such decision-making is irrational and harmful because it will most likely lead to additional suffering. In this case, the person choosing to over-eat ends up suffering in two different ways (wasted money and over-eating), as opposed to just one (wasted money) if they were to “cut their losses” – that is, to ignore the sunk cost and accept the fact that they can’t finish the whole meal they’ve paid for.

As such, falling prey to the sunk cost fallacy is also described as “throwing good money after bad.”

It is important to keep in mind that sunk costs are costs that have already incurred and cannot be recovered. Thus, they shouldn’t be a factor in future decisions anymore. Instead, when choosing the next course of action, the most rational thing to do would be to look at the current state of things and how the future is likely to turn up in regard to your investment.

Examples

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It is also known as “focalism”: The initial piece of information, such as a value or a certain trait, provides a focal point for our later decisions.

Anchoring can be both useful and harmful to individuals. For example, it can cause us to buy overpriced products because we “anchored” our judgment around the price that was first presented to us. On the other hand, it also helps us make quick, reasonably accurate estimates whenever needed.

What Is Anchoring?

Anchoring is the tendency to put disproportionate weight on the initial piece of information (the “anchor”) that is provided to us during decision-making. Consequently, the set anchor causes individuals affected by it to make subsequent decisions based on it.

Daniel Kahneman, the Nobel-prize winning economist, also explained this phenomenon in his best-selling book Thinking, Fast And Slow:

It [anchoring effect] occurs when people consider a particular value for an unknown quantity before estimating that quantity. What happens is one of the most reliable and robust results of experimental psychology: the estimates stay close to the number that people considered—hence the image of an anchor.

Effects

We use anchoring frequently and in a wide variety of decision-making situations: Whether we need to decide which product to buy, assess the level of our own happiness, mark the grades of our students, or guess what year Mahatma Gandhi was born, we tend to do it by using a certain value or piece of information as an “anchor”.

However, perhaps its most immediate effect is how it makes us perceive the value of products. Nobody likes paying more than they need to, however, marketers and salespeople are well aware of the bias and know how to use it to their advantage. As Rolf Dobelli put it in his book The Art of Thinking Clearly: Better Thinking, Better Decisions:

The “recommended retail price” printed on many products is nothing more than an anchor. Sales professionals know they must establish a price at an early stage – long before they have an offer.

Similarly, anchoring is known to play a significant role at the negotiation table, where the first offer works as the anchor. Once the anchor is set, the participants are biased toward interpreting information around it. Thus, the initial offer ends up having a considerable impact on the final price.

Examples and Studies

Dating and Happiness

In one study illustrating the anchoring bias, participating college students were asked two questions: “How happy are you” and “How often are you dating”^[1].

It turned out that the order in which the questions were asked had a huge influence on how happy the students reportedly felt.

When the question “How often are you dating” was asked first, the participants used their response as an anchor to answer the second question; they felt either more happy or sad depending on how often they said they were currently dating.

Wheel of Fortune

Interestingly, we are influenced by anchors even when they are random and completely unrelated to the issue at hand.

In an experiment conducted by Kahneman and his colleague Amos Tversky, the participants were asked to spin a “wheel of fortune”. The wheel was prearranged to stop on either 10 or 65, however, the participants were not aware of that^[2].

Afterward, they were asked how many African nations there were in the U.N. The results showed that the participants “anchored” their guesses on the seemingly random number given by the wheel: those whose wheel stopped at the high number gave higher estimates, and vice versa.

Value of Real Estate

In another study, it’s shown how experts may be influenced by anchoring as much as amateurs:

A number of students and professional real-estate agents were shown a randomly generated sales price of a house and were then given a tour around the house. After the tour was finished, they were asked to estimate its value.

Surprisingly, the results were similar for both groups: the higher the initial sales price (that was random), the higher both the students and the professionals valued the house.

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It influences, for example, how we make decisions and take risks regarding our personal finances. Consequently, understanding this bias and how it affects us can help improve one’s financial decision-making skills.

What Is Loss Aversion?

We, people, don’t like to lose our possessions.

What’s more, losing makes us more upset than gaining something of equal value; we feel the pain of, say, losing $100 more strongly than the joy of making $100 — in fact, twice as strongly^[1].

This is also known as loss aversion.

Effects

In particular, loss aversion has implications in the field of economics and personal finance. For instance, a strong fear of losing can cause both corporations and individuals to avoid financially risky decisions.

This can be seen as a double-edged sword: Although being averse to losses can help us avoid decisions that could lead to negative financial results, it may also prevent us from taking risks with the potential for reasonable returns.

This same effect also applies in other domains: In any type of decision-making situation, people may be inclined to dismiss ideas, theories, and solutions that are highly innovative but carry higher risks.

Besides financial context and risky decisions, it has been shown that loss aversion also creeps its way into relationships: For instance, one study found that, in interactions between married couples, it takes about five positive comments to offset one critical comment^[2].

Marketing

Loss aversion is also important to understand for marketing professionals.

According to the concept, showing your potential customers how your product will help them avoid something painful is likely to be a more profitable approach than showing that they would gain something positive.

Furthermore, it explains why people tend to react more strongly to an increase in prices than to a decrease^[3].

Individual Effects

In many situations, avoiding things that could potentially lead to losses is undoubtedly beneficial to us.

However, when the fear is too great, it may also prevent us from making rational choices. The reality is that, with most decisions, we have to risk giving up something in return for something else.

As such, being able to combat this tendency could prove to be highly advantageous for individuals. So, next time you are faced with an impactful choice, make sure to weigh both the possible downsides and upsides, as well as consider the likelihood of the different outcomes.

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In short: It describes the tendency of low performers to see themselves as more knowledgeable and capable than they really are. This happens because low-competence individuals tend to be unable to determine the true level of their own abilities, as well as recognize the skills of others.

What Is the Dunning-Kruger Effect?

Most of us can likely think of a situation where someone’s behavior was (likely) influenced by it. For example, it’s not uncommon to hear people make overconfident claims and give lengthy speeches about something that they, in reality, know much less about than they let others understand. Thus, people falling prey to this effect are also described to be on “Mount Stupid”.

Causes

The main reason behind it is that low-skilled people lack the needed self-awareness to properly assess their performance. As Dunning and Kruger explained¹:

Overestimation occurs, in part, because people who are unskilled in these domains suffer a dual burden: Not only do these people reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the metacognitive ability to realize it.

David Dunning and Justin Kruger (1999), “Unskilled and Unaware of It: How Difficulties in Recognizing One’s Own Incompetence Lead to Inflated Self-Assessments“

In other words, being unable to judge the level of own performance, and thus the performances of other people leads to an inaccurate sense of one’s capabilities.

Origin

The concept is named after David Dunning and Justin Kruger of Cornell University, who identified the phenomenon as a cognitive bias in their 1999 paper.

In their studies, they tested the subjects in three areas: grammar, logic, and sense of humor. The results showed that those individuals who got the lowest scores in the tests consistently rated their own performances higher than what the scores revealed. More precisely, people whose scores placed them in the 12th percentile ranked themselves, on average, in the 62nd percentile.

Impostor Syndrome

A psychological phenomenon known as “impostor syndrome” is the opposite of the Dunning-Kruger effect. It refers to the belief that one is not as competent as their achievements show and/or other people perceive them to be.

It involves the idea that one has succeeded previously due to chance and luck, not because they are skilled or talented, and that someone will eventually find out — hence the name “impostor syndrome”.

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