While my love for sports oftentimes helps influence my thinking on business, rarely do I have the opportunity to utilize my background in accounting towards my thinking on sports. However, the upside of a comfortable understanding of costs and projected benefits is seen quite often in sports, especially professional baseball.
In Major League Baseball, salaries are guaranteed (shoutout to you, MLB Players Association), meaning that when a player signs a $25 million contract spread across five seasons, that entire $25 million salary is guaranteed to be paid to the player. Traditionally (and to the expectation of the team and player), this salary will be paid over time as the player competes in games throughout the course of each season. However, if a team decides that they no longer want that player on their roster, and if no other team will trade for that player and take ownership of their remaining contract amount, then the original team could release the player, while still owing them the full contract amount, even though they are not on the roster any longer. Therefore, aside from any bonuses a player may be paid, once a team signs a player to a contract, the money associated with that contract should be viewed as a liability, or better categorized as a sunk cost. No matter how well or poorly that player performs for their team, the cost is now fixed. Unfortunately, not all baseball front offices seem to fully grasp how to account for costs that cannot be altered moving forward.
Imagine that your favorite baseball team signs a well-known player to a high-value contract. Based on previous performance, this seems like a fantastic investment to increase your team's chances of winning more games. However, because the player has been in the league for a while, they've aged significantly over time and are nowhere near their prime. So, the season starts with the player performing poorly, but everyone holds out hope - maybe the player just needs some time to get adjusted to playing on a new team and in a new city. But, throughout the season, the production continues to decline to a point where the player is well below league average in most major statistical categories, and it is difficult to see more value being produced by this player than by another available player on the bench or in the minor leagues. However, because the player is playing poorly and the contract value is so large, no other teams in the league are willing to discuss trading for the player, leaving your team on the hook for the still guaranteed salary.
At this point, your favorite team has a few options. First, they could bench the player and drastically decrease their playing time. This would allow other players, who may be more likely to produce value on the field and improve the team's chances of winning games, to play in their place. While original player would not be given as many chances to produce future value, this is likely fine since recent history and future projections indicate that the player may not produce value at all. Even if they did produce future value, it could just be as someone who comes off the bench, where the team expects very little production anyway. Additionally, the team could elect to outright release the player. This would remove any opportunities for the player to provide value, but at least they would not be making your team worse. Finally, the team could just keep playing the player as though they are someone who warrants the contract they signed. But this seems strange, doesn't it? If future projections are that the player is unlikely to return to former levels of output, and the team is going to have to pay their entire contract anyway, why would anyone knowingly invest playing time into the player and make the team worse, which would likely decrease the team's chances to win games, make the playoffs, and increase revenues? Simply put, baseball front offices are incredibly susceptible to the sunk cost fallacy.
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A sunk cost is a cost that has already been occurred that cannot be recovered. Think about the exercise equipment you have bought in the past. Once you buy the equipment, assemble it, and are past the date of being able to return it for a full refund, you can't make your money back that you spent. Sure, you could resell the equipment for a fraction of the original cost, but the money that you personally already spent is never coming back.
A sunk cost fallacy, however, is when you make additional investments just because you previously spent a sum of money and/or time in the past. Instead of making your decisions about investments based on future costs and benefits, you are focused on the emotional feelings associated with the historical costs and investments you have already made. With your exercise equipment, maybe you think that you need to use it because you already spent all of the money to own it. This is entirely the wrong way to view the situation. No matter how much you use the equipment, its associated costs will never change. You should want to use it because of the future costs you will have from not exercising and because of the future benefits that can be gained through exercising. You could even choose to resell it because then at least you'd recover some of your previously spent costs through some monetary benefits. Doubling down on an investment just because of resources and time already spent can lead to serious consequences and the loss of actually needed benefits, which is all due to the psychological bias we face with sunk cost fallacies.
Maybe you think sunk cost fallacies are only happening in environments like sports or in our personal lives. Maybe you think that there is no possible way sunk cost fallacies are happening in our professional lives because of all of the checks and balances we have at work and because work is driven by profits and losses. Unfortunately, biases like sunk cost fallacies are all around us, even at work, which means they are often either directly or indirectly affecting our teams. How are we as leaders putting ourselves in the best positions to see sunk cost fallacies at play so that we can ensure our team members are not negatively affected?
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An interesting display of a sunk cost fallacy has been playing out from the moment COVID-19 restrictions began to be lifted: return to office mandates. There are obvious qualifiers for this topic that do not make it a cut and dry decision (opportunities for new hires to more easily interact with colleagues, social activities, and more informal and equitable interactions with senior level leaders), just like why baseball teams play underperforming players with big contracts instead of benching them or releasing them (morale concerns, respect for the player, and not making future players think this could happen to them too). However, we should keep in mind that a significant draw for businesses in bringing their employees back to physical offices is to justify the costs of existing lease contracts.
For companies that have expensive office space leased, there can be an urge to ensure they are getting the "full value" out of the space available to them by having employees in the office using this space. However, because the lease is locked in, similar to a baseball contract being locked in the moment it is signed, all of those associated costs from the lease itself should be viewed as historical costs that cannot be returned. In the same way baseball teams need to think about the associated costs of continuing to play someone they shouldn't and weighing those costs against projected value, companies need to view the associated costs of bringing employees back to the office against the value of actually having them there. Associated costs with having employees return to the office would be calculated as variable costs (utilities, supplies, increased discretionary spending on events, and lunches that need to be expensed) and any benefits need to be viewed as opportunity costs (net benefits of returning to the office vs any additional action that could have been taken instead that could have produced a quantifiable amount of benefit, like letting employees work wherever they prefer to work).
Some organizations will claim that the benefits of returning to the office are "immeasurable", which seems strange for any business taking itself seriously to say. In reality, as with any business decision, we should begin by conducting a cost-benefit analysis of what it means to ask our employees and team members to so dramatically shift their lives because of a sunk cost fallacy of placing way too much focus on costs that cannot be recovered from physical office leases (or worse, putting way too much of a focus on being able to more easily control team members' lives, which is much creepier to consider). Even if an organization attempted to avoid an outright sunk cost fallacy by making an argument on paper that there is more short-term value in forcing individuals to the office, it's also not difficult to see the future costs of employees choosing to once again take more autonomy over their lives and leaving for a different situation that is less controlling and hindered by biases.
To keep our best talent, ensure individuals feel like decisions are being made with their best interests in mind, and avoid future costly decisions and investments that are influenced by sunk cost fallacies, we need to better understand how to recognize and combat them prior to falling prey to them.
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One helpful way we can combat sunk cost fallacies is to bring in outside perspectives to a situation. It is easy for us to suffer from conformation bias, which can lead us to only looking for the information that is in line with our predetermined decision. Instead, we can bring in the perspectives of individuals like our team members. Not only can we create forums for them to voice their viewpoints on certain decisions so that they can begin to feel some autonomy over their work lives, but we can receive needed insight from those closest to any future outcomes.
Additionally, we can put on our accounting hats (somewhat reluctantly for those of us who may be recovering accountants) and break down associated costs and benefits from decisions we may make. It's important to differentiate costs as either fixed or variable costs, as well as costs that are already guaranteed vs costs that can be discretionary. We also need to view benefits not just in terms of the benefits we would receive from that particular decision, but how those benefits differ from the ones we'd receive by deciding to do something else instead (ex: the benefits I'd receive from going to a concert with friends vs staying home to study for an upcoming exam).
Finally, as difficult as it can be, we can work to remove our own personal feelings about a decision. Perhaps it's easy to make a decision to have your team return to the office because you are comfortable with that environment, while claiming, "That's the way it has always been." However, if we do the things we've always done, we get the results we've always gotten. To grow and evolve, it's important to take our own feelings out of the equation and attempt to view choices more rationally and more through the lens of other team members who may not have our same experiences.
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We are all susceptible to biases like sunk cost fallacies. However, falling prey to these blind spots doesn't just affect us. It affects everyone around us who is going to feel the impact of our decision making. At work, this means our biases can potentially lead to negative impacts for the very individuals we should most be advocating for.
As I pointed out in my post on moral hazards, the first step for us to combat these biases is to create awareness of them. From there, we can leverage techniques to eliminate their negative consequences and ensure our team members are being led with not only the best of intentions, but also with the most reasonable and rational approaches.
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