Your Mind and Your Money: Irrational Escalation of Commitment

It’s the end of the week, and that means the last in the series of mental mistakes we make with our money.  If you’ve been reading all week (good for you if you have!), you’ve probably noticed that many of these mental flaws seem to stem from the same basic problem: your brain is bad at predicting the future.  You save everything in the hope that it will go up in value or make unrealistic assumptions about future odds.  Well, buckle up, because we’ve got one more irrationality to deal with:

Irrational Escalation of Commitment

You escalate your commitment when you continue to devote time and money to a course of action as a result of previous commitments.  If you’ve ever tried to climb a mountain (or attempted to reach some other physical or mental peak) and pushed yourself to go a bit further ‘because I’ve already come all this way’, you’ve escalated your commitment to a goal.  Such escalation becomes irrational when the rewards from completing your goal would come nowhere near to covering the expenses you’ve paid to complete the goal.  A business plan that’s already cost more than it could possibly recuperate but is continued anyway is an example of irrational escalation of commitment.

Escalator, Escalating... Get it?
Escalator, Escalating... Get it?

If all of these sounds rather similar to the sunk cost fallacy, you’re onto something; irrational escalation of commitment frequently results when people (or organizations of people like businesses and governments) refuse to see or acknowledge that the money they’ve spent already is sunk, and the insistence that increased expenditures are needed to justify the initial spending.  It becomes an endless spiral of spending more and more to justify previous, sunken costs.  Speaking of which…

Irrational Escalation of Commitment Examples

-The most commonly cited example of irrational escalation of commitment is the dollar auction. The short version is this: a professor offers to give the highest bidder in the class one dollar.  There’s a catch, though: not only will the highest bidder have to pay out his bid to get the dollar, but the second highest bidder will have to pay his bid as well, without receiving anything.  The bidding starts low, at one cent, and quickly increases, until someone bids one dollar.  That should be the end; after that, people are paying more than the dollar is actually worth with each bid, so the bidding should end.

But, because of the rules of auction, the second highest bidder also has to pay, and so he has the incentive to bid even higher; if he wins with a bid of $1.01 rather than losing with a bid of $0.99, he’ll only have to pay one cent rather than ninety-nine.  The dollar bidder has the same motivation; if she wins the auction, she’ll have to pay less than if she comes in second place.  With this seemingly logical thought behind them, they can (assuming the professor allows them to continue) bid the price of the dollar up to many, many multiples of its actual value, only stopping when one bidder runs out of money to make progressively higher bids or the professor calls the auction off.  With each bid, the bidders were doing what would optimize their financial interest, but the overall process could, assuming the professor forces them to pay up, end up costing each of them far more than the value of the prize they’re seeking.

-As mentioned already, anytime a manager opts to continue a project after spending more money than it could possibly recuperate, it’s an example of irrational escalation of commitment.  It might be done to save face or even the manager’s job, but for the company as a whole the process is wasteful and counterproductive.

-Many forms of ‘Keeping Up with the Jones’ can be considered a type of irrational escalation of commitment; as with the dollar auction, even if you ‘win’ and have a more impressive car, lawn, or house, you have still ended up spending more than you could possibly hope to recuperate by selling (assuming there’s even a market for your improvements; last I checked, there’s not too much demand for used lawn ornaments).

Beating Irrational Escalation of Commitment

Well, if you ever find yourself in an economics class and the professor wants you to bid on a dollar bill, just don’t do it!  For the more real-life examples, always keep the potential goal in mind, and aim to keep your costs well under the potential rewards.  If you’re trying to compete in a costume contest to win a $100 grand prize, the cost of your costume(s) should be less than $90 or so; otherwise, even if you do win, you won’t have much to show for it.

Also, be sure to recognize when your costs are sunk, and have the willingness to walk away.  Yes, maybe devoting just a little bit more money to your so-far failed project will enable it to be a success, but it still won’t bring back the money you’ve already spent.  More likely, any attempts to justify that spending will just lead to increased spending in the future, with no increase in rewards.

The key to stopping irrational escalation of commitment is to attempt to be as rational as possible, and look forward to the potential rewards rather than behind to the (sunk) costs you’ve already paid.  Remember, you can’t change the past, but you can do things differently in the future!

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