What Is the Sunk Cost Fallacy?

Also Known As: Escalation of Commitment, Retrospective Cost

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Definition:

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The sunk cost fallacy is a cost that has already been incurred and cannot be recovered.

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There is a justification of increased investment of money, time, and resources in a decision, based on the cumulative prior investment ("sunk cost"). This is despite new evidence suggesting that the cost, beginning immediately, of continuing the decision outweighs the expected benefit.

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Sunk Cost Fallacy Examples:

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In business, an example of sunk costs may be investment into a factory or research that now has a lower value or no value whatsoever.

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For example, $20 million has been spent on building a power plant; the value at present is zero because it is incomplete (and no sale or recovery is feasible).

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The plant can be completed for an additional $10 million, or abandoned and a different but equally valuable facility built for $5 million.

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It should be obvious that abandonment and construction of the alternative facility is the more rational decision, even though it represents a total loss of the original expenditure, the original sum invested is a sunk cost.

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If decision-makers are irrational or have the wrong incentives, the completion of the project may be chosen.

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See Also: Cost overrun, Disposition effect vs. endowment effect, Escalation of commitment, Foot-in-the-door technique, Gambler's fallacy, Loss aversion, Prospect theory, Psychology of previous investment