The Sunk Cost Effect

This cartoon’s pretty brilliant.

According to WhatIs.com, the sunk cost effect is the tendency for humans to continue investing in something that clearly isn’t working. This tendency is due to time/effort/money already invested in the endeavor at hand. In the cartoon to the right, the sunk cost effect is shown by the dog’s irrational behavior to follow through with further digging even after not finding his bone after digging a bit.

This behavioral quirk is quite popular in the investing field. Instead of cutting losses, investors have an inclination to hold onto shares of a company after the shares fall in value, in hopes that the value would increase. These investors are reluctant to admit that they’ve made a bad investment and would prefer to hold onto those shares instead of reinvesting in another company.

To provide another example: I’ve recently been debating about switching my paid music streaming subscription service from Spotify Premium to Amazon Music Unlimited. Being that I’m an Amazon Prime member, my Amazon Music Unlimited subscription would cost $7.99 per month. In my current Spotify Premium plan, I’m dishing out $9.99 per month. If following rational economic theory, I would switch my subscription over to Amazon because… well, it just makes sense financially! However, in being the “irrational” consumer that I am, I haven’t switched over due to the fact that I keep thinking about all the time I’ve invested in creating my Spotify playlists - a clear case of the sunk cost effect.

"Satisficers"

It's quite fascinating to reflect on how irrational people can be.

And it's perfectly normal to be irrational. We can't be completely rational all the time right? 

This irrationality is part of our bounded rationality. According to Herbert Simon, recipient of the Nobel Prize in Economics in 1975, people have cognitive limitations and because of that, we go about making sub-optimal decisions in our everyday lives. Through this lens, people unconsciously act as "satisficers" in their decision-making, seeking to make a satisfactory decision instead than an optimal one. In order to facilitate the decision-making process, we act on instincts, habits, heuristics, cognitive illusions, and biases - leading us to "satisficing" decisions.

This is innate within all people. During this unconscious part of the decision-making process, we formulate stories - stories that support our beliefs.

Thomas Gilovich, Author and Professor of Psychology at Cornell University who has contributed to the behavioral economics field, describes these stories as a result of "Patternicity", the tendency to create meaning from events. While this evolved trait (think hunter-gatherers hearing rustling in the grass and believing it might be a predator) greatly served our ancestors, "patternicity" leads to irrationality, poor decision-making & bias.

While the topic of ethics relating to behavioral economics makes for another blog post, marketers have been using the underlying biases in "satisficers" to create effective marketing campaigns advantages for decades. From loss aversion to anchoring, there are plenty of biases for marketers to utilize. With that being said, potential consumers can offset this targeting by being "intuitive scientists" - a nice little secret from Thomas in the video above.

Image Credit:  Behavioral Scientist

Image Credit: Behavioral Scientist