On the sunk-cost effect in economic decision-making: a meta-analytic review Business Research

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Within this context, note that the preliminary analysis indicated that many of these factors were not significant predictors of effect size. Thus, even if we initially coded 16 effect size moderators (see Appendix 1), the analyses focused on the seven effect size moderators listed in Tables 3 and 4. Beginning with a comprehensive review in multiple databases, we searched for scholarly articles that had combinations of the keywords “sunk-cost effect” or “sunk-cost fallacy”, as well as for alternative spellings, also in German.

  1. Dogfooding refers to a situation where a product team uses their own product or service before releasing it to the market as a test case.
  2. When you are aware of the different psychological factors that cause sunk cost fallacy, you’re more likely to make rational decisions and form healthy, sustainable budgets.
  3. If you don’t, you run the risk of spending even more money that you’ll never recover if economic conditions don’t improve fast enough.
  4. Yes, the sunk cost dilemma is prevalent in business contexts where investments have been made in projects, products, or ventures that are not performing as expected.
  5. That being said, shifting from an introspective mindset to an outward-looking mindset (one that’s more focused on the product rather than the impact we’re having on it) is easier said than done.

Within-trial contrast is a provocative alternative because it presupposes that overvaluation can occur even when the reward and initial investment are cross-dimensional. Tests of the state-dependent valuation learning hypothesis have been particularly successful, whereas the evidence for within-trial contrast is inconclusive. Yet the proposal that manipulations negatively affecting hedonic state prior to reinforcement also enhance value is appealing and would add generality to the effect if proven reliable. An early experiment by Arkes and Blumer (1985) illustrates this decision error. Those who received no discount attended the most plays, followed by those who received small discounts and finally by those who received the larger discount. Similarly, pigeons prefer to complete a particular work requirement (a fixed-ratio schedule) even when they could escape such a requirement and complete a lesser one (Navarro & Fantino, 2005).

It is a term used in economics and decision-making processes to describe costs that are irrelevant to future choices. By understanding the concept of sunk costs and applying the sunk cost method, individuals and organizations can make more rational and efficient decisions. First, a basic problem of every meta-analysis is that primary studies do not provide all the information needed to make the results perfectly comparable.

Therefore, we find support for the idea of payment depreciation (Gourville and Soman 1998; Prelec and Loewenstein 1998). In line with this argumentation, it is surprising that academic literature on the sunk-cost effect has not clearly distinguished between these two types of decisions (e.g., Arkes and Blumer 1985). To date, the lack of differentiation combined with the ambiguous definition of the sunk-cost effect does not allow for comparability or generalization of the respective findings. There is neither a comprehensive review that elaborates on different effect sizes nor, and more important, a review that examines possible moderators of the effect for both decisions.

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Be that as it may, the mechanisms underpinning the sunk cost error are yet to be determined. Several proposals have been put forward over the years, but all have met successes and failures. This hypothesis presupposes that the change in state caused by the reward is in the same dimension of the initial investment (viz., energy).

How Do Sunk Costs Affect Decision-Making?

Sunk costs don’t necessarily need to be financial, though in business, it usually is. For example, how you spent your morning is a sunk cost and could, for the most part, have no bearing on how you spend the rest of your day. Let’s take a look at how the Sunk Cost Dilemma works and how it relates to rational thinking.

Hiring Bonus Sunk Cost

The occasions on which subjects initially accepted the offer provided the opportunity for the sunk cost error to emerge. Mice, rats, and humans escalated their commitment to a particular offer as prior time investment increased. A second limitation of our study is that not all the studies we included are based on data sets collected with the same research design. Most studies use experimental data and examine the sunk-cost effect with hypothetical scenarios.

If a sunk cost can be eliminated at some point, it becomes a relevant cost and should be a part of business decisions about future events. Imagine a non-financial example of a college student trying to determine their major. A student may declare as an accounting major, only to realize after two accounting classes https://business-accounting.net/ that this is not the career path for them. The sunk cost fallacy would make the student believe committing to the accounting major is worth it because resources have already been spent on the decision. In reality, the student should only evaluate the courses remaining and courses required for a different major.

Fennema and Perkins (2008) also argue that education plays an integral role. They examine the moderating effects of academic training, financial expertise, and decision justification involving sunk costs on the decision to continue a real estate project or not. Comparing the decisions of MBA students and certified public accountants with the decisions of psychology students, they show that trained individuals made better decisions. Staw and Fox (1977) examine the impact of a temporal separation of multiple progress decisions in a business case study. Surprisingly, the invested amount of resources did not steadily decline with time, but varied in the way participants invested significant larger financial resources in the third decision than in the second.

Even if two options lead to the same outcome, people tend to be biased toward the choice they view as a gain over one they view as a loss. When a business chooses to pursue an alternative platform or service that does not subsequently perform well or become profitable, the amount spent exploring the new direction is sunk cost. In progress decisions, the sunk-cost effect in a series of temporally separated but economically linked decisions increases with time. Let’s take a look at some common sunk cost fallacies, why they’re bad, and what we can do as product managers to avoid them.

Sunk Cost refers to the expenses or investments that have already been incurred and cannot be recovered. It is a term commonly used in economics and decision-making processes to describe costs that have already been paid and cannot be reversed. A small business leadership team choosing to continue sunk costs is a reflection of poor financial and business judgment. It’s important to reflect on the type, the amount, and the duration of sunk costs. Also known as retrospective cost, a sunk cost is a financial investment that cannot be recovered. With respect to our second hypothesis, we find that the sunk-cost effect becomes smaller when the time between the first payment and the actual consumption decision increases.

Taken together, these results suggest that the sunk cost effect may reflect non-standard measures of utility, which is ultimately subjective and unique to the individual. This website is using a security service to protect itself from online attacks. There are several actions that could trigger this block including submitting a certain word or phrase, a SQL command or malformed data. Yes, salaries are not recoverable; they are expenses incurred by the company. For example, business owners may believe they have a good chance of success if they invest their finances in a particular venture, despite a similar venture failing in the past.

To make the decision to close the facility, XYZ Clothing considers the revenue that would be lost if production ends as well as the costs that are also eliminated. If the factory lease ends in six months, the lease cost is no longer a sunk cost and should be included as an expense that can also be eliminated. To make this decision, the firm compares prospective sunk costs the $15 additional cost with the $20 added revenue and decides to make the premium glove in order to earn $5 more in profit. The cost of the factory lease and machinery are both sunk costs and are not part of the decision-making process. A company spends $50,000 on a marketing study to see if its new auburn widget will succeed in the marketplace.

What Is a Sunk Cost vs. a Fixed Cost?

This mistake may result in improper long-term strategic planning decisions based on short-term committed costs. Now that we have a good understanding of sunk costs, let’s explore the concept of opportunity costs. Opportunity costs are the potential benefits that are sacrificed when choosing one alternative over another. It is a type of cognitive bias arising from people’s tendency to get emotionally attached to their investments.

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