Think about what your house, condominium, or some other valuable asset might be worth in today’s market. Did the price you paid for it affect your answer? “Ignore sunk costs,” accounting professors and economists tell us. The amount of money and effort we’ve invested in the past, they say, is irrelevant to our future investments.
This advice is easy to follow in the classroom, but much harder in the real world. Logically, you know that the purchase price of your home has little bearing on its current value. But when you’ve poured all of your energy and savings into a piece of property, especially one as personal as a home, you’re likely to have trouble putting the purchase price out of your head.
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An Example of a Negotiation Involving Sunk Costs
In one negotiation simulation, Kristina Diekmann, an associate professor of management at the University of Utah, and her colleagues found that when appraising a property, both sellers and buyers are affected by the price the seller originally paid for it. This purchase price did not affect assessments of the property’s value, but it did affect both buyers’ and sellers’ bid expectations and reservation points (the reservation point is the point at which the BATNA, or the best alternative to a negotiated agreement, becomes preferable to starting or continuing a negotiation). For more information on the dynamics of reservation prices in bargaining scenarios, see also Protect Yourself from Competitive Expectations.
During slumps in the housing market, few of us will accept the possibility that our investment has failed to appreciate much, or has even declined in value. Homes can remain vacant for months, even years, while sellers stubbornly refuse to lower their asking price. Psychologically, further escalating our commitment to our initial investment seems like the only option. Our sunk costs—and those that others have made—weigh on us and set us up for the escalatory trap. This is true in many negotiation settings, including salary disputes and contract talks with long-term clients (for more insight into salary negotiations, see also How to Ask for A Higher Salary).
How can you avoid falling into the sunk costs trap? Before entering a competitive negotiation, consider whether you have a sound basis for doing so—or if you are simply hoping to justify your previous investments. You’ve heard it in your accounting classes, but it bears repeating: money, time, and energy you’ve spent in the past should rarely affect your future commitments.
Avoiding a negotiation entirely may not sound like the most satisfying option. But negotiators who recognize competitive traps are often able to reframe the situation into one that’s less competitive, more cooperative, and ultimately more rewarding—financially and psychologically—for everyone involved.
Comment below: Do you have a hard time ignoring sunk costs when buying a high-ticket item like a house or car?
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Negotiation Examples in Business and Negotiation in China: The Importance of Relationship Building – How the importance of interpersonal relationships in the People’s Republic of China impacts bargaining strategies.
Claim your FREE copy: Business Negotiation Strategies: How to Negotiate Better Business Deals
Discover step-by-step techniques for avoiding common business negotiation pitfalls when you download a copy of the FREE special report, Business Negotiation Strategies: How to Negotiate Better Business Deals, from the Program on Negotiation at Harvard Law School.
Adapted from “Do You Know When to Walk Away?” by Max Bazerman, Harvard Business School and Program on Negotiation Faculty.
Originally published October 2009.
A great, current, example of sunk cost is the Arena being built in Sacramento for the Kings. Every time I check, the cost of building the structure is increasing substantially from the original estimate. The contractors know that they can do that because no one wants to have to take it down and eat the cost. What good is half an Arena?