Zen and the Fallacy of Sunk Cost

Productonomics is my own little invention that applies an “economic way of thinking” to technology product development, and the Fallacy of Sunk Cost is, IMO, a highly applicable economic principle. Proper understanding and application not only benefits the products we make, but it benefits morale and company culture.  To give credit where credit is due, Steve Bronstein, a former colleague and a current friend, is really the one who stuck this phrase into my head and made me see the light (he very effectively argued against a position I held by dropping this science on me).  I realized at that point how crucial the concept is in decision-making and strategic thinking, but I also realized how counter intuitive it is.

What is it?

The principle is easy enough to understand, and it can probably be summed up most succinctly by the “dont throw good money at bad” idom, although that’s not all there is to it.  A short definition that I like is “Once the money (or time or effort) is gone, then it’s gone. There’s no point in worrying about this” (from Plonkey Money). This may be oversimplifying it a bit, but there is a ton of stuff out there on the web that can explain it better than I can (links below), and I want to focus specifically on how it can help product development. Most of what you find out there is associated with money management/investing, but the principle holds for any decision-making situation where spent resources come into play.

How is it useful in Product?

Our decisions now only affect the future and have no relationship to the past – -  that’s the jist, and logically, it is not hard to understand this. If I buy a ticket to a bad movie and I can’t get a refund, sitting through the movie doesn’t re-acquire any of the value I have lost – I’m better off walking out and doing something that gives me more utility/return – that’ s the rational thing to do anyway. But now let’s consider a situation that many of us have been in – the team has been working on a roadmap feature-set for months… discovery, design, prototyping – you name it. Its been all consuming and buckets of sweat and tears have gone into it. When the assumptions were made and the numbers were run months ago, it seemed like a home run, but just recently – we either realized we were wrong and nobody wants this thing, or a bunch of external factors changed (and when doesn’t this happen?) or both. What changed isn’t important – - competitive environment, economic environment, regulatory environment, technology stack, legal framework, etc., etc., etc. – - the point is that what to do NOW is what’s important, and what was decided 6 Months ago, while perhaps relevant for knowledge, is not relevant in the decision calculus going forward.

It comes down to two positions:

  • We should just kill the entire project and do something else.
  • We have put too much work into this and gone too far to quit now – we will have lost all of that work.

Well, assuming that the core assumptions are accepted to be true – (that we were wrong or the landscape is no longer receptive)  - choice number 1 is the correct choice.  Now, its important to make the distinction between the “we were wrong” vs. “things outside our control changed”, because each situation presents its own challenges to the people on the team, but let’s be clear that in either case –  bullet #1 is the way to go.  All that hard work is in the past, and without a time machine, we can’t retrieve the resources. All we can do now is make the best decision possible that defines our path from today onward, so continuing to throw resources at something we all feel is doomed is a fools errand.

What about the “Zen” Part?

Well, that all sounds fine and dandy and rational and what-not, but here’s the rub… the rational decision is likely to be unpopular, and if the culture of the company doesn’t allow for failure to be acceptable, there is going to be political face-saving shenanigans, finger pointing, and dogmatic group-think takeover. This quip from the Skepdic Dictionary says it all:

To continue to invest in a hopeless project is irrational. Such behavior may be a pathetic attempt to delay having to face the consequences of one’s poor judgment. The irrationality is a way to save face, to appear to be knowledgeable, when in fact one is acting like an idiot.

Ouch, but true… and I’ve been there… oh, have I been there. What’s the answer?  Well, that’s where the “Zen” part comes in – its really about the company culture from the top down. We can’t be afraid of failure or creative destruction (we’ll be talking a lot about ‘cd’ and Schumpeter in the future), and this is the essence of the tech start-up, is it not? One of my favorite business books, Getting to Plan B, is devoted entirely to this concept: adapt and overcome.  Well, you can’t adapt if you don’t make mistakes and then recover from them quickly, so understanding this fallacy and injecting that understanding into the culture of the team is important.  The “Zen” part is being able to be in the moment, acknowledge that a change in direction is the best course, and let go of the past – “bend like a reed in the wind” (yes, that is a Dune quote). To sum this one up in manner in which most people can relate, how about this quote (relayed by my friend and former colleague, Mike Tatum from Whiskey Media):

Would you rather be rich or right? – a very wise (and probably rich) man

Don’t Take it Too Far

Just like any knowledge, this can be misinterpreted or taken too far, so to be clear, this principal does NOT propose that we do not or should not learn from the past. Knowledge and experience, of course, should shape our decision making. Also, if I am to be fair, the product scenario that I described above is really referencing a “Sunk Cost Dilemma“, and there is a significant distinction. The “sunk cost dilemma” adds a more realistic framework for real-life — specifically introducing uncertainty and multiple events. In my example above, I said “assuming that the core assumptions are accepted to be true – (that we were wrong or the landscape is no longer receptive)“. Well, the reality is that we probably aren’t often that certain that the “we were wrong” assumption is true, and so we are only making the best decision we can with the information we have – thus, uncertainty. In a Game Theory context, these decisions are made multiple times, and if you make the decisions based strictly on a calculus of ONLY looking at open costs (not sunk costs), you actually get into a situation where the aggregate of the each “correct” decision creates a negative result over time.

As decisions are only made considering open costs but not sunk costs, each single decision is computed to be beneficial. But in the end, the overall payoff of the project is negative. While the project progresses towards disaster, the decision not to go on with the project gets more and more unlikely. The project is like a train: once it has been put on a track, it is very difficult to change its direction.

I’m gonna go out on a limb here and say that I think a fundamental understanding of the sunk cost fallacy is still incredibly beneficial, and this scenario, in a way, argues the same broad point that I am making – - momentum for momentum’s sake is not productive, and realistic, honest decision-making is good.  Essentially, this dilemma is created by “too much of a good thing”, and understanding the fallacy is just another tool in the box… its not dogma. Oliver Lehmann’s “Visionary Tools” offer some insight into how to avoid this dilemma, and I find them to be good common sense tactics – nothing we wouldn’t already be trying to do anyway (short reporting cycles, defined roles, proper interpretation of data… common sense, in short).

Say It Loud, Say It Proud

The best place to start changing culture is with yourself, and this is a process.  Just working in a ”but… i could be wrong” now and then is a good start.  Saying “I WAS wrong, and here’s what I propose we do about it” in front of a room full of people is perhaps the ultimate test. Ultimately, if the nature of the relationships with your clients, customers, co-workers, and investors is honest, humble, and thoughtful, then saying “I’m wrong” means that you don’t really have to say “I’m sorry”.

Resources:

http://sunk-cost.behaviouralfinance.net/

http://www.visionarytools.com/decision-making/sunk-cost-dilemma.htm

A not really review of ‘The Social Network’

Ok – confession time:  I didn’t see the movie, I don’t plan to, and this isn’t a film review at all.  I am merely using the subject matter of the film as a device to further what, for me, is the more central and important lesson of this tale … and that is that ideas are cheap.

I will defer to the wise and eloquent Lawrence Lessig to provide a nugget of wisdom in a way that my mere mortal brain cannot.  The following is a quote from an article/review he published in the New Republic about the “Facebook Movie” – Its an amazing bit of insight:

But from the story as told, we certainly know enough to know that any legal system that would allow these kids to extort $65 million from the most successful business this century should be ashamed of itself. Did Zuckerberg breach his contract? Maybe, for which the damages are more like $650, not $65 million. Did he steal a trade secret? Absolutely not. Did he steal any other “property”? Absolutely not—the code for Facebook was his, and the “idea” of a social network is not a patent. It wasn’t justice that gave the twins $65 million; it was the fear of a random and inefficient system of law.

Whatever your ideas are about intellectual property, or whether or not you feel sorry for the “downtrodden” defendants in the film, execution is what matters, and real, successful execution isn’t just technical prowess – it requires a deep set of skills like vision, perseverance, and adaptability (for advice on how to acquire these illusive skills read Eric Ries – but, I digress).  When Zuckerberg launched  “Facemash”, the pre-cursor to Facebook, it was Oct 2003. I had been working on the internet and related fields,  at that time,  for nearly 6 years, and I can tell you — “social networking” on a large scale was going to happen –  it was already happening in many proto-FB  forms.  Also, I can’t think of a product where the Network Effect has more of an impact on success than for a social network, so the winner was always going to be the one with the most users, period.  Lets not also forget that Facebook improved and became bigger and better BECAUSE of its users (again… network effect) – - the product grew and adapted, not because Mark Zuckerberg gave glorious birth to every feature in advance of demand – -  but because he was smart enough not to.

So cheap, it can’t be good.

Here is a common cheap idea life-cyle that I’ve seen occur so many times within my own world of digital media:  The user AND company expect “A” which is appealing, if it works, but it doesn’t work, because the business model / the marketplace / the legal system / current technology don’t support “A” – the company proceeds anyway, because they still cling to the possibility of reaching the unrealistic, but appealing “A”,  even though there are significant barriers out of their control or lack of funding or whatever.

Truly good ideas, IMO, have depth … a path … a unique signature.  In a way, an idea is like a snowflake, and initially, only the owner of that idea has that version. To take this idea to the extreme, I could say that I have an idea to build a time machine.  Hell – from the demand side, that’s a smashing idea… just think of it! The fact that is violates the laws of physics (well, maybe not technically, but that’s for another discussion) makes it absurd, but even beyond that, if you were to press me on my thoughts on getting from A-Z (concept to launch), my only option would be to grin back at you and say .. “A Time Machine, Man! Just Think of it!” Its not a bad idea… its just an extremely cheap idea… so cheap as to be asymptotic to 0.  The point is that give me any one or two sentence ideas, and I have no doubt that there are probably hundreds, if not thousands of people who have thought of this “half-idea”, but it is the entrepreneur with the vision and insight to see a real path to execution that makes the idea into a good one.

Zuckerberg Jr.

Another internet magnate who has been much maligned for NOT having ideas, but rather, copying/stealing ideas is Mark Pincus of Zynga. Now, don’t get me wrong… there are some lawsuits out there that accuse Zynga of literally stealing code and doing things that violate contracts and break the law – I don’t condone this at all… if they are found guilty, they should suffer the rule of law, but I do think they get a bad rap for some of the “copying” charges. I found this anonymous gamer post on message a board pretty salient:

Zynga was pulled into court for making Mafia Wars, by the original makers of Mob Wars. Mob Wars is an inferior and much lesser-known game to Mafia Wars, even though Mob Wars came first (which is sad). Zynga just has an amazing dev team and knows how to market.

That being said, Zynga is a total copy cat…they just cross-promote the hell out of their games, which makes them so popular. At this point, they’re crapping gold…no matter what new game they make, it becomes an instant hit.

I don’t know scientifically if this is the “general feeling” out there, but if you take it on the face of it, and lets just say “ok – he’s right” – well, Zynga is good at developing and good at marketing… 2 pretty darn important pieces of the puzzle, don’tcha think? I think the really sad thing is that the Mafia isn’t getting their cut… I mean, weren’t they what made these games possible in the first place? Maybe Coppola should have sued Scorcese for making Good Fellas. Being a “copy-cat” in the sense described above may be seem unethical or anti-innovation, but I disagree on both counts, and in an innovative economy, its absolutely necessary.  The internet and software is all about copying, iterating, and improving… the whole industry evolved this way – its Hayek’s  emergent order in its most virulent form.

So, I’ve given up on my time machine, but there are idea men out there who never stop…