Sunk Cost Effect
We’re reluctant to pull out of something we’d put effort into.
When we put time and effort into something, we’re motivated to make it work. We therefore often continue to invest into it even if it brings us losses. Examples include continuing to pump money into a failed business idea, or attending a play when sick only because the tickets were pre-purchased.
Arkes, Hal R., and Catherine Blumer, “The psychology of sunk cost”, Organizational Behavior and Human Decision Processes, Vol. 35, No. 5, December 1985, 124-140.
The Sunk Cost effect is a great example of our past efforts influencing our current decisions. It’s been demonstrated in a number of classic behavioural economics experiments over the years.
In one of these, conducted by Arkes and Blumer back in 1985, participants were offered various types of tickets to the local theatre. Some were offered the ticket at full price ($15), some were offered the ticket with a $2 discount and others were offered the ticket with a $7 discount. They found that those who paid full price used more tickets (i.e. attended more plays), over those who bought them at either of the two discount prices. Interesting, if a little crazy!
Even more crazy was another study in the same series, where it was found that people were willing to give up an opportunity that would be more enjoyable, as a result of the sunk cost effect. Basically, when asked to imagine themselves in a situation where they made a mistake and accidentally booked two ski tickets on the same date, most chose to give up the more pleasurable, yet less expensive ticket in favour of the less pleasurable, yet more expensive ticket. What this shows is that we’re more willing to give up a more positive experience to account for a larger cost that we’ve incurred. Alas, this raw number-crunching clearly overpowers our rational pursuit for a fulfilling life. I gently weep for humanity, I really do…
But it’s not all bad, however. In an recent study in Singapore on the effect of the sunk cost effect on car purchases (Ho, Png & Reza, 2014), researchers found that the larger the sunk cost in buying a car, the more the owner actually drove that car. Ha! This study therefore has strong implications for the pricing strategy of all durable goods.
Takeaways for Decision-Makers
- Powerful Up-selling Informing customers of a cost that’s already been incurred can help increase sales. For example, when customers put through an order for some trousers in an m-commerce app, along with the price, seeing a message that reads “complete the look with this black shirt for only $20” can dramatically increase average basket value. It does this by reminding customers how much they’ve already invested towards their overall clothing purchase, and highlighting how small the extra sum required would be to ‘complete the set’ - which itself plays on our natural desire to complete collections.
- Value highlighting to smooth out kinks If, however, you’re struggling with capacity underutilisation because of booking cancellations at the last minute, notify consumers in the run-up to the event of what they’d booked, and its value. This will help to increase the sunk-cost effect, and therefore their desire to attend, or perhaps to gift the tickets to allow a friend to attend on their behalf.
- Increasing post-sale purchases While traditional consumer theory suggests that pricing goods such as cars at a low selling price to entice consumers is a solid strategy, the recent research coming out of Singapore suggests that increasing sunk costs by pricing such goods higher can result in more use and therefore wear & tear, which will therefore lead to a higher rate of purchase on post-sale services and products. This could return more over the long run, and help develop a long-term brand commitment.
- Reminding as a means of post-selling As an aside, offering complimentary check-up services on durable goods may remind consumers of the cost they’ve already incurred. This has the strong potential to increase purchase of post sale consumables (such as antivirus software for a laptop).
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- Aspirational membership schemes and belonging The category size bias provides a credible explanation for why we human beings tend to associate with large groups that are viewed favourably by society. Being part of a large and “desirable” social group can make others believe that we also possess the many qualities of its members. For small businesses, it suggests that forming or being a part of a consortium or large and high quality networking group can dramatically elevate your brand image.
- Communicating category sizes to nudge effectively Highlighting the differences between the large and small categories is highly likely to enhance the effect of the Category Size Bias. For instance, for software companies, stating that there are 10 features in the premium version versus 4 in the free version will help nudge a decision towards the premium version
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- The findings from this braingem can nudge better healthcare choices, encourage consumption of a given product, and lead to more confident consumer decisions.
- We mistakenly believe that items in larger categories have a higher probability of being picked than ones in smaller categories, despite all items having an equal chance of being picked.
- We’ll spend or gamble more money on items put in larger categories.
- We’re more likely to take action from tasks when they’re in a bigger list, over a smaller list.
- We once we put something into a group, we perceive it to adopt all the characteristics of that group. This suggests that small companies should foster alliances with similarly-principled, more established companies.
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