It’s a pity to abandon a project in which a lot has already been done

There are situations when previous investments of effort or money lead to the fact that the horse has already died, but it’s somehow a pity to abandon it. This could be stretching out old tech stack, finishing up legacy, investing in an unprofitable project, finishing up unclaimed code, or even when a student is studying in a specialty that has disappointed him.

In psychology and behavioral economics, this effect is called the sunk cost trap. As practice shows, its influence on human life is very great, but the consequences are so-so.

The very term “sunk costs” (in the original they are literally “drowned” – sunk cost) came from economics. It denotes expenses incurred as a result of past decisions and which cannot be recovered either in the present or in the future. These include, for example, the cost of sand and cement from which the foundation of the building is built. The foundation is difficult to reverse.

The concept of “sunk cost fallacy” comes from behavioral economics, a science at the intersection of behavioral psychology and economic theory. It turned out that this effect works not only with money and investments, but also in other areas, from politics to family relationships and everyday activities. Ultimately, any human decision can be viewed in terms of the resources expended and the result obtained.

So what we have had a hard time with needs to be completed!

This happens at various levels of social organization: on the scale of entire countries and international unions, organizations and, finally, the individual.

A large-scale sunk cost trap at the macro level might look something like this:

Infrastructure megaprojects (“constructions of the century”). For example, Channel Tunnel exceeded the initial project cost several times and has not yet reached payback. In the 1960s, Montreal began planning to build Mirabell Airport. It was assumed that it would partially replace another airport, Dorval, by taking over international flights. But due to its poor location and insufficient transport infrastructure, it did not become popular. Dorval, meanwhile, operated as normal, quietly continued serving domestic flights, and eventually changed its name to Montreal Pierre Elliott Trudeau International Airport. And Mirabel became a cargo ship in 2004.

Unsuccessful social projects. Perhaps the most significant case is the construction of the Pruitt-Igoe housing development in St. Louis from 1954 to 1956. It was originally conceived as inexpensive housing for the American middle class. However, after two years, most of the tenants left, and the area itself turned into a criminalized ghetto. Trying to recoup the $36 million spent on construction, city leaders tried several times to improve the area and reduce crime, spending another $7 million. In the end, nothing worked out – Pruitt-Igoe continued to self-destruct until it was demolished in 1972.

For example, in North Korea in 1987 they started building the Ryugyong Hotel. 330 meters, 105 floors, 3000 rooms, seven revolving restaurants, a casino, nightclubs and lounges and $750 million for all this miracle of architectural and engineering thought. The hotel could have cost even more, but construction was suspended after the collapse of the USSR, which also invested in it. In 2008, they decided to complete its construction at the expense of Egyptian investors. After finishing work and covering the facades with blue glass, which cost $400 million, Ryugyong began to look much more attractive. In November 2012, Kempinski, an international hotel operator, announced its intention to operate the hotel. By the way, it turns out later that this was only a preliminary agreement.

The partial opening of the Ryugyong Hotel was planned for mid-2013, but a delay was announced in March. The reasons were not stated, but some publications suggested that international tensions, economic risks and construction problems could play a role in this. In general, “Ryugyong” still hasn’t started working.

The mistake of sunk investments is often made by commercial or investment companies, which, by the nature of their activities, are required to behave rationally. There are many examples:

In 2005, Microsoft tried to jump on the compact media player train that had already been occupied by Apple's iPod. Despite the fact that the Zune player turned out to be quite good and users responded favorably to it, the company was too late in releasing the product, conducted a poor marketing campaign and did not enlist the support of major music labels. But, despite low sales, Microsoft released its player for another 6 years – the project was closed only in 2012. A similar situation has developed with the Windows Phone OS, which has been trying to be revived for even longer (since 2010).

Theranos, founded in 2003 by Elizabeth Holmes, was able to attract more than $10 billion in investment by declaring the development of a “revolutionary” method of biochemical blood testing. Even after it was revealed to be a scam in 2015, the investment company Fortress Investment Group still provided the startup with $100 million because it had previously acquired several patents from Theranos.

Situations are typical in organizations when the implementation of a solution (for example, CRM) is intended to improve work efficiency, but in the end, due to technical or organizational shortcomings, it, on the contrary, begins to interfere. But the money for implementation has already been spent – and management decides to continue using this product, spending even more money on its development.

However, it is still necessary to be careful when explaining the situations described above and other similar situations solely as the results of a cognitive error:

Firstly, such large projects are complex in nature and are determined by many factors, of which economic ones are often not the most important. For example, the US lunar space program was primarily scientific and political in nature, rather than commercial. And from this point of view, it completely justified itself.

Secondly, despite their unprofitability, many projects stimulated the development of various industries, such as microelectronics, transport, mineral exploration, etc., and created a technological foundation for future projects. In particular, the Apollo program contributed to the miniaturization of computers, and the propulsion design (many weak but cheap engines instead of a couple of powerful but expensive ones) of the unsuccessful Soviet N-1 “lunar” rocket is now successfully used on super-heavy launch vehicles Falcon Heavy.

Thirdly, the profitability of many projects can manifest itself in the long term – for example, the companies of Jeff Bezos (Amazon) and Elon Musk (Tesla, SpaceX) reached a profitable level many years after their founding.

The sunk loss trap works more clearly at the level of the individual, since such situations are easier to analyze in terms of the impact of various factors on decision making. A textbook example is given by Richard Thaler in his book The New Behavioral Economics. Let's say a person paid $1,000 for a six-month membership to a tennis club, where he can use the gym every week. After 2 months, his elbow hurt, but he, gritting his teeth, continued to go to the gym. And I stopped doing this only when the pain became completely unbearable.

Another example, also given by Thaler from real life. His friend Joyce had been arguing with her six-year-old daughter for some time because at a certain point she did not want to go to school in the dresses that had been specially bought for her for first grade. Once Joyce invited Thaler himself to explain to her daughter the simple economics of dresses.

However, Thaler explained to Joyce herself that wearing dresses would not return the money spent on them. And if Cindy already has pants and shorts that she doesn't have to spend money on, then there's nothing wrong with letting her skip the dress. Shocked by this discovery, Joyce calmed down and stopped conflicting with her daughter over a trifle.

On a personal level, the deadlock trap doesn't only work in situations directly related to money. For example, many people watch a movie to the end, even if halfway through they realize that they don’t like it. Or they continue to be in a relationship with a partner, even if this relationship only brings emotional and physical discomfort. Or they work in a job they don’t like only because they received the appropriate education at one time. In these situations, we are not talking about money, but their equivalent (that is, “sunk costs”) is the time spent, emotional or physical effort.

It happens that the sunk cost trap is quite conditional: a person bought food, he didn’t like it, but he continued to eat it anyway (“because he paid for it”). But still, the main function of food is saturation, and not satisfaction of taste preferences. That is, the trap is triggered only when the result of the investment is not fully justified. Yes, a person may not like the food, but he can still eat it, that is, the sunk costs seem to pay off. But a sediment remains.

Why is the sunk cost trap triggered?

For a long time, economists viewed man as an absolutely rational economic agent. This made it easier to create harmonious mathematical models.

Of course, supporters of the classical and neoclassical schools of economics were not fools and were well aware that a real person is not always rational. But they regarded deviations from rational behavior as an error – much the same as physicists do when models do not agree with reality. In other words, classical economics did not so much deny as neglect the irrational economic behavior of people. So, from her point of view, a person, when making a decision, does not pay attention to sunk costs, but is guided only by future benefits and costs.

Over time, however, it became clear that these deviations from Homo Economics had too strong an impact on the explanatory and predictive accuracy of economic models. It turned out that economic agents (individuals, organizations, governments) often take into account sunk losses and this must be taken into account. There are several reasons for this.

Loss aversion. For the first time, this effect was clearly described in their works by Israeli psychologists Amos Tversky and Daniel Kahneman, the creators of behavioral economics. It lies in the fact that a person tends to worry more intensely about a loss than to rejoice at the benefit received, even if in numerical terms they are absolutely equal. The authors themselves explain loss aversion through the prism of their prospect theory: when making a decision, a person is guided not by the absolute amount of wealth possessed, but by its change relative to a certain reference point. This effect is probably due to evolution – in the past, an ancestor who reacted more strongly to a threat than to a potentially profitable prospect had a greater chance of surviving. For example, a lost portion of food today threatened quite probable death from starvation, while a possible additional portion did not guarantee an extra day of life.

Possession effect. This cognitive distortion was noticed by economist Richard Thaler and the same Kahneman. Its essence is that a person is more likely to prefer to keep what he already possesses than to receive an object that is perhaps more profitable, but not in his possession. Thus, abandoning an unprofitable, but “our” project in favor of a “not yours,” but potentially more profitable one, becomes a problem.

The error of optimism and pessimism. Situations in which the sunk loss trap occurs involve evaluations of past and future actions. And they combine in an interesting way two cognitive distortions: a person’s desire to overestimate his abilities, on the one hand (the effect of overconfidence), and on the other, to overestimate the likelihood of losses. For example, when investing in a project, he is overly optimistic about its future, while at the same time being too pessimistic in assessing how difficult it will be to abandon it.

Commitment bias. This distortion consists of conforming to a pattern of behavior once accepted, especially one that is demonstrated publicly. Commitment bias means that the person who initiated the project or plays a key role in its implementation is less likely to refuse to complete it, even if he sees it as unprofitable. Thaler attributes this to the fact that in this way the responsible person is trying to preserve his reputation and at the same time provide protection against future criticism. After all, having, for example, a stadium built (albeit over budget and schedule), it is easier to fend off attacks from an angry public than to justify the closure of an unfinished project.

Thaler, developing the concept of sunk costs, connects it with his idea of “mental accounting”, about which

we already wrote

. Its essence is that, analyzing his financial assets, a person mentally divides them into separate accounts and conducts a kind of imaginary accounting. So, in this “mental ledger”, sunk costs, the result of which was not used, are considered as “loss”. The greater this loss, the more intensely a person experiences a feeling of regret and guilt for his “wastefulness” (remember here the illustrative example of Joyce and her daughter). Therefore, he strives to justify the invested sunk expenses by achieving the result for which he incurred these costs. Even if the result itself does not bring him pleasure or benefit, and in some cases even causes inconvenience.

The theory of anticipated regret looks at sunk losses a little differently. If prospect theory, developed by Kahneman and Thaler, analyzes human economic behavior through cognitive distortions, then this concept is based on the fact that the main motive of his actions is to minimize future regrets for a wrong decision. At the same time, a person, as it were, analyzes his current actions through the prism of his attitude towards them in the future, a kind of dialogue takes place between the “present” and “future” self. And from this point of view, the behavior of a person who refuses to abandon an unprofitable project in favor of a more profitable one becomes rational . The focus simply shifts from achieving an economic outcome (profit) to reducing feelings of guilt and regret.

It may seem that the sunk cost trap is an unambiguous evil that should always be avoided. In practice this is not always the case. For example, this mental property can be used to develop self-discipline. Many people specifically buy a gym membership to encourage themselves to go to it, even if they don’t feel like doing it.

And what to do with all this?

So, it is clear that in most cases the sunk cost trap prevents us from managing our finances more effectively and making rational decisions. But how to get around it? The very first and most important step is to understand that this effect really exists and that you, most likely, are also susceptible to it. This is normal, this is how human psychology works. But understanding this mechanism will already force you to be more rational about your economic (and not only) behavior. For example, to evaluate a decision, you can use the following list of questions:

How do I define failure and success in this situation?

What is the real probability of a successful outcome of my decision?

How would I feel about the decision of another person in a similar situation?

What am I afraid of losing by abandoning the project?

The most important thing to understand in this whole situation is that you need to evaluate this or that decision from the perspective of future costs and benefits, and not past investments.

The second important step is to return logic to project assessment, that is, to be based on objective data. To do this, set specific and measurable goals that you want to achieve using various methodologies (for example, SMART or OKR). If during implementation the project does not achieve these goals, it means that it needs to be adjusted or completely abandoned. It would also be a good idea to introduce quantitative performance indicators that will allow you to accurately measure success or, conversely, failure. This way, you can base your decision on your current situation rather than on past investments. If you have several possible scenarios to choose from, create a decision matrix that specifically lists the costs and benefits for each.

Finally, the third step is to set the frequency of checking the selected strategy. Many undertakings at first seem (and may even actually be) profitable. But over time, the situation changes and the project turns from profitable to unprofitable. To avoid missing this point, it is worth re-evaluating it regularly using pre-established goals and performance indicators.