Sunk Cost, Loss Aversion, and Cannibalism: Lean Muppet Series Post 3

After losing an “I” and his tie, this New York baker is ready for Cookie to leave.

I cannot count the number of times I, as a consultant, have been called in to diagnose an obvious problem.

Cookie Monster…now he has an obvious problem.

While we would all like to see many of our current television hosts eaten by monsters, it’s clear to even little kids that Cookie Monster would be better served by eating pie than Guy Smiley.

Pie is the optimal solution. But at least as far as we see, Cookie Monster has chosen Smileycide as the solution to his problem, and is committed to it.

We often identify a solution, create a plan, then commit to a number of actions to achieve that plan. With each action we take, alternatives psychologically become more unpallatable.

You can see in the future, Cookie Monster catching up and actually eating Guy Smiley and then saying, “Hmmmm, me no like eat Guy Smiley after all.” But each time Cookie Monster chases Guy, he finds that he’s invested more of his time and energy into Project EatGuy and is less likely to stop.

Psychologists and economists call this the “sunk cost fallacy,” and even though every MBA student in the world learns about it, we still see it happen.

In lean manufacturing this is a specific type of waste called “muda,” work that we do that adds no value.  In this case, chasing something considered inedible is not going to result in a delicious snack.

But I’d like to focus on a different lesson – one more fudamental that, if we strive to solve it, we’ll eliminate muda anyway.

Lean teaches us to avoid inventory. Inventory is the stuff we create, are in the process of creating, or are the parts for the things we anticipate creating.

I remember in 1979 my father was involved in creating a business incubator in our hometown called Triangle East. It was in the abandoned Geer Mobile Home plant. All my father’s projects were family projects and so at one point I found myself going through the old plant cleaning up. The was inventory everywhere – desks, chairs, doors, bolts, and so forth. Tons of inventory that we either recycled (such that we could in 1979), threw away, or served as fascination for a 14 year old boy. All of it constituted waste because it would never be used to biuld a mobile home.

In knowledge work we build up conceptual tons of inventory. Reports, files, software code, policies, processes, procedures, half explored ideas, concurrent tasks… all these things decrease our ability to complete work or to ship products.

But the more conceptual inventory we create, the more sunk costs we perceive. The more sunk costs there are, the less likely we are to improve. Psychologists call this tendency “loss aversion.”

We can illustrate this idea with this ridiculous equation:

Y = Cookie Monster’s hunger
G = the perceived value of eating Guy Smiley
Cx = the number of times Cookie Monster chases Guy around the counter

Cx * Y = G

Note that while the actual value of eating Guy Smiley will be zero, the perceived value of eating him increases with every iteration.

What’s worse is that if Cookie’s goal is partially achieved, he is unlikely to learn from it, but will actually become more entrenched. So, say he catches Guy Smiley and eats an arm (who knew the Muppets could be so dark?), he will work harder because loss aversion is telling him “you missed the tasty part.”

Our stakes may be higher in the non-felt world, but the scenarios are no less ridiculous. Pets.com is the classic example where free shipping of discounted cat litter attracted tens of millions in VC money and much more at IPO. Anyone not caught up in dot com fever could see that building a business model around shipping bags of clay (maybe the only thing worse would be bags of lead) was not likely to produce profits.

Another quick point here is that while Cookie Monster was never the brightest bulb in the Muppet marquee, he was and remains a nice guy. By nature he does not cannibalize other muppets. He had simply bought into an idea and found himself in a sunk cost spiral.

Always look for the pie.

This is third in a series of Lean Muppet Posts: For a list of Lean Muppet posts and an explanation of why we did this… look here -> Lean Muppets Introduction

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3 Responses to Sunk Cost, Loss Aversion, and Cannibalism: Lean Muppet Series Post 3

  1. Pingback: The Lean Muppet Series: Introduction | Personal Kanban

  2. Thanks for the post, Jim. I’m really enjoying your Muppet series. And I know of a project I’m currently working on where over-production of inventory has led to lots of waste and where the psychology of sunk cost has played a significant role. I’m fervently hoping never to repeat some of the mistakes made on this project. :-)

  3. Kevin Young says:

    I work in education, and I feel like I am surrounded by bad ideas that are built upon other bad ideas that are built upon what might have once been a good idea. The Sunk Cost problem is everywhere and is reflected in the ever-growing ratio of non-faculty (administrative and support) to faculty, the ever-increasing costs of tuition, and the growing unpreparedness of incoming students. How do we get rid of bad ideas entirely instead of just building additional layers of bad ideas on top of them?

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