Concorde fallacy

Concorde fallacy

Industry	Economics
Products	Concept in economics and business decision-making

In the fields of economics and business decision-making, a sunk cost—also referred to as a retrospective cost—represents an expense that has already been incurred and cannot be recovered. This contrasts with prospective costs, which are future expenditures that can be avoided by choosing a different course of action. Essentially, sunk costs are past outlays irrelevant to forthcoming decisions. Nevertheless, individuals often let these costs influence their choices, such as when deciding whether to repair existing assets.

Bygones principle

According to classical economic theory and mainstream microeconomic thought, rational decision-making should consider only prospective (future) costs. Choices should be based exclusively on present alternatives and their anticipated outcomes. Costs already incurred are deemed irrelevant, often described metaphorically as "water under the bridge" or "crying over spilt milk". For example, if a factory initially estimated to cost $100 million promised returns of $120 million, but after spending $30 million the expected value falls to $65 million, it is economically sound to abandon the project rather than invest an additional $70 million. Conversely, if projected benefits exceed $70 million, continuing the investment is justified. This guideline is known as the bygones principle or sometimes the marginal principle.

The bygones principle is rooted in normative decision theory and rational choice theory, particularly the expected utility framework, which advocates ignoring outcomes unaffected by current decisions. Past expenditures, including sunk costs, fall into this category.

This concept also aligns with "separability," meaning decisions depend solely on available options and not on the historical path taken. This principle underlies various economic models such as sequential decision processes and game theory constructs like sub-game perfect equilibrium.

Prospective costs remain pertinent until resources are irrevocably committed and should be incorporated into decision-making. For instance, purchasing movie tickets involves avoidable costs until the transaction is finalized.

Both retrospective and prospective expenses may be categorized as fixed costs or variable costs. However, economists often caution against lumping sunk costs into these categories indiscriminately. For example, a one-time $400 million payment for enterprise software installation represents a sunk expense; ongoing monthly service fees constitute fixed costs. The initial payment should not be amortized as fixed but treated distinctly. Variable costs might include operational expenses like data center electricity consumption.

In certain scenarios, disregarding sunk costs contradicts the bygones principle yet remains rational. Managers might persist with projects to convey determination or evade blame, even when it does not benefit the company. Furthermore, private information unavailable externally may justify continuation of projects that appear irrational from an outsider’s perspective.

Fallacy effect

Despite the bygones principle, sunk costs frequently sway actual behavior. Individuals commonly continue investing resources after initial expenditures—a phenomenon termed the sunk cost fallacy, colloquially known as "throwing good money after bad". This tendency leads to hesitation in "cutting losses" and can cause ongoing investment in unsuccessful ventures or relationships.

Research by Rego, Arantes, and Magalhães highlights this effect in committed relationships: people who have invested time or money are more inclined to sustain those relationships. Although rational decision-making advises ignoring sunk costs, emotional and financial commitments often drive continued involvement similar to persistent investment in failing projects.

In corporate settings, this effect has resulted in reluctance to terminate unprofitable initiatives. For instance, numerous U.S. utility executives were hesitant to halt economically unviable nuclear power plant projects despite escalating losses. Once hailed as offering "energy too cheap to meter," nuclear power lost favor due to costly mismanagement revealed through prudency reviews.

The phrase "Concorde fallacy" exemplifies governmental failure to disregard sunk costs: despite commercial failure, British and French governments continued funding the Concorde supersonic jet project due to political and legal pressures.

Sunk costs frequently arise in business decisions. Expenses such as marketing campaigns or research and development (R&D) investments are typical examples—once spent, these should not influence future pricing or investment choices. For example, pharmaceutical firms charging high prices to recover R&D outlays fall victim to this fallacy; pricing ought to reflect market dynamics irrespective of past expenditures.

Dijkstra and Hong found emotional states exacerbate the sunk cost fallacy. Negative emotions and stress increase the probability of persisting with failing projects, especially under significant cognitive burden, underscoring psychological factors’ importance.

The sunk cost effect can contribute to budget overruns. For example, abandoning a partially completed $20 million power plant in favor of constructing a new $5 million facility is economically rational despite forfeiting prior investments. Yet decision-makers might irrationally finish the original project due to incentives aimed at avoiding visible losses—highlighting a distinction between sunk cost fallacy and incentive-driven behavior.

Some studies also note instances where individuals prematurely abandon prior investments in favor of new opportunities, representing a reversal of the usual sunk cost effect.

Plan continuation bias

Plan continuation bias represents a subtle cognitive distortion that drives individuals to persist with an initial plan despite evolving circumstances. Within the aerospace sector, this bias significantly contributes to accidents; a 2004 NASA investigation identified this tendency in 9 of 19 incidents involving aircrew.

This phenomenon creates hazards for both ship captains and pilots who maintain perilous courses instead of aborting. A prominent case is the Torrey Canyon oil disaster, where the tanker ran aground after the captain chose a risky path rather than accepting a delay. Research into aviation mishaps reveals plan continuation bias as a primary factor—present in 11% of 279 approach and landing incidents and implicated in 42% of 76 examined accidents.

Two principal drivers underlie this bias: an excessively optimistic assessment of success, often employed to alleviate cognitive dissonance following commitment to a decision, and a sense of personal responsibility that hinders acknowledgment of mistakes.

In corporate projects, budget overruns and schedule slippages frequently stem from the planning fallacy alongside related biases such as undue optimism, resistance to admitting failure, groupthink, and reluctance to abandon sunk costs.

Psychological factors

Behavioral economics highlights four central psychological contributors to the sunk cost effect:

• Framing effects, where decision-making varies depending on whether options are presented in a positive or negative light; individuals tend to avoid risk when framed positively but pursue risk under negative framing.
• Overoptimistic probability bias, causing investors to overestimate returns after committing resources.
• Personal accountability, which amplifies sunk cost behavior among those who feel responsible for prior investments.
• The urge to avoid seeming wasteful, prompting continued investment to rationalize earlier expenditures.

Collectively, these factors indicate that the sunk cost effect reflects subjective and individualized assessments of utility.

Framing effect

The framing effect contradicts the principle of extensionality, which asserts that choices should remain consistent regardless of how information is presented. Instead, framing alters preferences even when outcomes are logically identical.

For example, two mathematically equivalent scenarios framed differently should lead rational decision-makers to make the same choice; however, framing often distorts these preferences.

Kahneman & Tversky (1979) demonstrated valence framing effects: presenting a "sure thing" option in either a positive or negative manner influences decisions despite equivalent outcomes. For instance, describing an outcome as saving 200 lives versus letting 400 perish are analytically identical but framed distinctively.

Ellingsen et al. classify framing effects into three socio-economic theories: 1. Variable sociality hypothesis—frames impact internalized social norms or preferences. 2. Social image hypothesis—frames shape how decision-makers believe others perceive them, affecting their conduct. 3. Expectation effects—frames influence expectations about others' behavior, which subsequently guides one's own actions.

Overoptimistic probability bias

In 1968, Knox and Inkster conducted research involving 141 horse bettors—72 who had recently placed a $2 wager and 69 who were about to do so. Their findings revealed that individuals who had just made the bet rated their horse's likelihood of winning higher (an average rating of 4.81 on a 7-point scale) compared to those preparing to place a bet (average rating of 3.48). This demonstrated that confidence in success tends to increase after committing to a decision. Comparable results were observed among horse owners and further supported by subsequent studies showing inflated probability assessments during decision-making processes.

Sense of personal responsibility

Staw and Fox examined 96 business students tasked with deciding on R&D investments within a struggling company division. Participants were divided into two groups: one told they had previously made an unsuccessful investment (high responsibility), and the other informed that a former manager was responsible (low responsibility). When asked to allocate $20 million for new investments, those in the high responsibility group committed significantly more funds ($12.97 million versus $9.43 million), indicating that feeling personally accountable heightens dedication to earlier decisions. These findings are consistent with other research linking personal responsibility to the escalation of commitment in business contexts.

Desire not to appear wasteful

Individuals who purchase event tickets in advance but find the experience unenjoyable often face a semi-public commitment by attending. Leaving prematurely may expose their poor judgment to others, which many wish to avoid. Moreover, having already paid, they might perceive early departure as squandering their financial outlay or alternatively take satisfaction in acknowledging the opportunity cost associated with their time.

Neuroeconomics and neuroscience approaches

Recent investigations have revitalized interest in understanding how the brain processes sunk costs. Assessing sensitivity to sunk costs is complex, as distinguishing these from anticipated future returns proves difficult. In a comparative study involving humans, rats, and mice, Sweis et al identified an evolutionary underpinning for sensitivity to sunk costs.

This line of inquiry prompts exploration into the evolutionary origins of this neural function, its adaptive value, and how different brain circuits produce such valuations depending on situational context or individual conditions. Current research aims to clarify how neurons represent sunk cost sensitivity, its development following specific decisions, and its potential influence on emotional burden.

See also

• Disposition effect
• Endowment effect
• Escalation of commitment
• Region-beta paradox
• Foot-in-the-door technique
• Prospect theory
• Psychology of previous investment
• Stop-loss order
• Thinking, Fast and Slow

Further reading

• Amankwah-Amoah, J. (2014). A unified framework of explanations for strategic persistence in the wake of others' failures. Journal of Strategy and Management, 7(4), 422–444.
• Arkes, H.R., & Ayton, P. (1999). The Sunk Cost and Concorde effects: are humans less rational than lower animals? Psychological Bulletin, 125(5), 591–600.
• Bade, Robin; Parkin, Michael. Foundations of Microeconomics. Addison Wesley, 1st Edition, 2001.
• Bernheim, D., & Whinston, M. Microeconomics. McGraw-Hill Irwin, 2008.
• Doody, Ryan (2020). The Sunk Cost 'Fallacy' Is Not a Fallacy. Ergo: An Open Access Journal of Philosophy, 6(40), 1153–1190.
• Kahneman, D. (2011). Thinking, Fast and Slow. Farrar, Straus and Giroux.
• Klein, G., & Bauman, Y. The Cartoon Introduction to Economics Volume One: Microeconomics. Hill and Wang, 2010.
• Samuelson, Paul; Nordhaus, William. Economics. McGraw-Hill International Editions, 1989.
• Sutton, J. Sunk Costs and Market Structure. MIT Press, 1991.
• Varian, Hal R. Intermediate Microeconomics: A Modern Approach. Fifth Ed., 1999.