Did you know that 70% of projects fail, with 52% of them experiencing scope creep (PMI 2018)?
In today’s fast-moving business landscape, it’s crucial to recognise when it’s time to pivot or even abandon a project. However, many companies fall prey to the sunk-cost fallacy, the tendency to keep pouring resources into a project simply because of how much has already been invested, rather than focusing on its future potential.
Capital is the fuel that drives competitiveness, and wasting it on failing projects drains the very resource you need to stay ahead.
To ensure you’re making the smartest decisions, it’s vital to understand this common bias, recognise the warning signs, and implement proactive strategies to avoid costly mistakes and ensure your capital is directed towards projects with real future potential.
1. What Is the Sunk-Cost Fallacy?
The sunk-cost fallacy occurs when someone continues investing in a decision, project, or venture based on the resources already committed, rather than evaluating its future potential. These past investments, whether they be in time, money, or effort, are “sunk” and cannot be recovered, but they influence decisions, making it difficult to walk away from projects that no longer make sense.
For example, a business might continue funding an underperforming product because millions have already been spent developing it, despite the fact that the market is showing limited interest.
2. Why Do We Fall for It?
The sunk-cost fallacy is deeply rooted in human psychology, making it a difficult bias to overcome. Here’s why we’re so prone to falling into this trap:
- Emotional Investment: When teams or leaders have spent significant time and energy on a project, it’s easy to become emotionally attached, leading to poor decision-making.
- Fear of Failure: Admitting a project isn’t working can feel like an admission of failure. Rather than face that discomfort, many businesses prefer to keep pushing forward, even if the project is no longer viable.
- Loss Aversion: Humans are wired to avoid losses more than we are to seek gains. The fear of “wasting” past investments leads to more irrational behaviour, even when it’s clear the project won’t succeed.
- Optimism Bias: There’s often hope that just a bit more funding or time will turn things around, even when all the data says otherwise.
3. How to Prevent the Sunk-Cost Fallacy
Prevention is always better than cure. By taking the right steps early on, businesses can avoid falling into the sunk-cost fallacy entirely. Here are some proven strategies:
Market Analysis: Start with Data
Before committing any significant resources, conduct thorough market analysis. Understand customer demand, market trends, and competitive dynamics to ensure your idea is viable. Making data-driven decisions at the start reduces the likelihood of investing in a project that’s doomed to fail.
Validate Product-Market Fit Early
Continuously test whether your product or service meets the real needs of your target market. Engage in pilot programs, gather feedback, and assess market conditions regularly to ensure that your product or service has long-term potential.
Use Design Thinking
Employ design thinking by putting the user at the centre of your problem-solving process. Focus on rapid prototyping and testing with actual users, ensuring that you catch potential issues early, before large investments are made.
Adopt Agile Methodologies
Agile frameworks encourage continuous assessment and incremental progress. Breaking your projects into smaller sprints allows for frequent evaluations of success and viability, so you can pivot quickly if needed, without wasting excessive resources.
Set Clear Success Metrics and Exit Strategies
Before embarking on any project, define clear metrics for success and establish exit points. This ensures you’re always reassessing based on current progress and aren’t emotionally attached to past investments.
4. How to Mitigate the Sunk-Cost Fallacy
If your business is already caught in the sunk-cost trap, it’s not too late. Here’s how to mitigate its effects:
Rational Reassessment
Step back and review the project with an objective, data-driven perspective. Focus on current and future potential, not past investments. Ask yourself, “If I were starting this project today, would I still invest in it?”
Bring in Unbiased Stakeholders
Invite third-party consultants or team members who were not involved in the original decision-making process. Their fresh, unbiased perspective can help you evaluate whether to continue or abandon the project.
Encourage a Learning Culture
Create a company culture where admitting failure is not seen as defeat but as a learning experience. When employees feel safe acknowledging that something isn’t working, they are more likely to speak up early, before excessive resources are wasted.
Smaller, Incremental Investments
Rather than committing large sums of money or extensive time upfront, take an incremental approach to investments. This way, you can evaluate progress at each step and pivot or stop as needed.
5. How to Recognise the Sunk-Cost Fallacy
Recognising the sunk-cost fallacy early is crucial to avoiding further waste. Here are common signs that you may be trapped:
- Justifying Continued Investment Based on Past Spending: If your main reason for pushing forward is how much has already been invested, it’s a red flag.
- Ignoring New Information: If you’re disregarding new data that contradicts your original plan, this is a sign that past investments are clouding your judgement.
- Reluctance to Abandon a Failing Project: If it feels impossible to let go of a project despite clear evidence that it’s not working, the sunk-cost fallacy may be at play.
- Focus on Recouping Losses: If your primary motivation is to recover what’s already been invested rather than focus on future success, it’s time to reassess.
6. Real-World Examples of the Sunk-Cost Fallacy
Queensland Health Payroll System
In 2007, Queensland Health embarked on a project to replace its outdated payroll system. The new system, intended to be delivered by IBM, was originally budgeted at AUD $6 million.
Even when it became clear that the project was struggling with significant cost overruns, design flaws, and implementation delays, the Queensland Government continued to push forward. The considerable resources already committed led decision-makers to keep pouring in more money rather than reassessing the viability of the system.
By the time the system went live in 2010, it was plagued with major issues, including incorrectly paid staff, unpaid wages, and overpayments, which led to significant financial and operational chaos. The cost ballooned to over AUD $1.2 billion in total by 2013 (Chesterman 2013; KPMG 2012).
Conclusion: Smarter Decision-Making, Fewer Losses
The sunk-cost fallacy is a powerful bias that affects individuals and organisations alike, but by understanding its causes and taking proactive steps to prevent it, businesses can make smarter, more rational decisions. Using market analysis, validating product-market fit, leveraging design thinking, and adopting agile methodologies will help you avoid unnecessary investments. And if you do find yourself trapped by sunk costs, reassess objectively, seek external perspectives, and encourage a culture of learning and flexibility.
Ultimately, avoiding the sunk-cost fallacy leads to better outcomes, fewer wasted resources, and stronger business growth.
References
Chesterman, R 2013, Queensland Health Payroll System Commission of Inquiry, Queensland Health Payroll System Commission of Inquiry, viewed 23 February 2024, <https://drive.google.com/file/d/1ZxyWqK3xuF8Pb7OWhLYZv2dpoE6yyMce/view>.
KPMG 2012, Review of the Queensland Health Payroll System, KPMG, viewed 23 February 2024, <https://drive.google.com/file/d/1CYkU94RXKmip0JNRnOFx8k3zZrU-57C1/view>.
Project Management Institute [PMI] 2018, Pulse of the Profession 2018: Success in Disruptive Times, viewed 23 February 2024, <https://www.pmi.org/-/media/pmi/documents/public/pdf/learning/thought-leadership/pulse/pulse-of-the-profession-2018.pdf>.