The Sunk Cost Fallacy, aka “throwing good money after bad”, is the irrational but common human behavior of continuing to do something not because of the return on investment going forward but because it is too painful to feel like you’ve wasted the money already sunk into the endeavor. Such behavior is very common in large companies, with fat product/project portfolios that are difficult to trim due to political reasons. The opportunity costs associated with sunk cost projects can be huge. Imagine what you can do with the money and people that would be freed up from cancelling even one of those projects. By applying some Lean principles to your portfolio planning process, you can avoid sunk cost fiascos and work toward being a more efficient and innovative organization.
Some high profile sunk cost traps include:
The Concorde – The British and French governments continued to fund the “commercial disaster” joint project due mostly to political reasons.1
Farmville – “Farmville players are mired in a pit of sunk costs. They can never get back the time or the money they’ve spent, but they keep playing to avoid feeling the pain of loss and the ugly sensation waste creates.” 2
The Iraq War – Many have interpreted the rationale for continuing the Iraq War past the point of meeting initial objectives as a perfect example of sunk cost fallacy. 3
One of the suggestions to avoid the sunk cost fallacy is to get opinions from a different set of people periodically, according to John Hammond.4 This helps to prevent the tendency to protect past decisions in order to avoid being associated with a failed project.
But the Lean concept of continuous planning may be the best antidote to sunk cost failures. This is because it provides a framework for continuously inspecting the value of continuing a project. You can do this with annual planning, but you only have the opportunity to inspect at a predetermined time, so even if you maintain a healthy process of periodically reevaluating the ROI on each project, on the average you will continue a project for six months past the point where the ROI turns negative.
Continuous planning also offers a subtler advantage to avoiding sunk cost scenarios. With annual (or coarsely interactive) planning, decision making tends to be based on dividing up a budget. Projects in progress almost always get consideration for continuance because people usually only do the ROI estimation for new projects. However, with continuous planning, it is easier to make the value judgment “is this worth continuing?” a natural part of the process.
- Weatherhead, P.J. (1979). “Do Savannah Sparrows Commit the Concorde Fallacy?”. Behav. Ecol. Sociobiol (Springer Berlin) 5 (4): 373–381
- “The Hidden Traps in Decision Making” John S. Hammond, Ralph L. Keeney, and Howard Raiffa, HBR
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