When making a decision, one of the worst errors is that of sunk costs; continually investing time, energy, and money into a project or course of action that is not meeting its performance expectations or goals (Robbins, 2005). Sunk cost errors are rooted in the human psychological need to persevere and succeed regardless of insurmountable obstacles. This need is emotionally compounded as more and more resources are invested into attaining an outcome that is logically implausible.
From a purely economic perspective, sunk costs refer to costs that have "already been committed and cannot be recovered" (Mankiw, 2007, 297). These costs should be ignored when making future decisions because there is no course of action that would be able to recover these resources, especially the time that has already been lost. Although this concept is easy to understand, people do not always make decisions rationally. Instead many allow feelings of regret to cloud their better judgment, and continue on a failing path instead of admitting defeat, letting go, and avoiding future losses.
For astute managers, and people in general, however, understanding the psychology behind sunk costs can be very beneficial. A shrewd negotiator, for example, can deliberately cause someone to feel as though they have already invested a great deal into a project so that they will be more willing to settle on less-than-desirable terms. In fact, this negotiation technique is used by real estate moguls, such as Donald Trump. Better known as the “Invested Time Principle,” this technique states that one of the best ways to get a seller to lower their price is by asking a lot of questions, having many meetings, and waiting to make an offer. The goal is to make the seller spend as much time as reasonably possible trying to sell the property to you. This works because “the more time a person has invested in a transaction, the less likelihood he or she is going to give it up…People hate the idea of having wasted time on something that doesn’t work out, after they have spent enough time on something, they’ll do anything they can to salvage the transaction” (Ross, 2005, 66). In other words, the best resource to make an opponent waste is their time, because they will almost always make the sunk costs error and agree to a course of action that they should logically not agree to.
Sources:
Mankiw, N. Gregory. (2007) Principles of Economics. Forth edition. Thomson South-Western.
Robbins, Stephen P. and Mary Coulter. (2005) Management. Eighth edition. Upper Saddle River, NY. Pearson Education Inc.
Ross, George H. (2005) Trump Strategies for Real Estate; Billionaire Lessons for the Small Investor. John Wiley & Sons, Inc.
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