Greedy Goblin

Wednesday, January 6, 2010

Sunk cost fallacy

Today's analysis is about another psychological bias (ape-subroutine) that can make your profits go away.

You made some investment on something. This investment cannot be unmade. For example you leveled inscription after reading it somewhere that it's a money-printing factory. You spent 2000G in herbs, books and opportunity cost of your time.

Now you found that the idea is maybe not so good and you must make a decision to proceed or not. For example you found that there is an AH camper who undercuts you as soon as you log out. Your original plan was to sell a few "hot" glyphs for every class around 30G, buying out cheaper ones if necessary. You obviously can't do that with the camper around. You can go deep undercutter, juggling with 2000 glyphs, listing them around 4G and getting 2G profit on 400 sold in every 2 days. Or you can just abandon the idea and level some other profession.

The rational decision would be made between the following two options:
  • I go deep undercutter accepting the lower profit/week
  • I level another profession for 2000G
However the loss-aversive ape-subroutines make the victims to actually compare the following options:
  • I go deep undercutter accepting the lower profit/week
  • I level another profession for 2000G and lose the 2000G invested into inscription
Actually the money invested into inscription is already lost. Your situation is equal to the guy's who just bought an account on e-bay and found that the character has inscription. The fact that the first case you spent 2000G on inscription and in the second case you got it in the package with the gear you wanted to buy is irrelevant. Or should be.

Social people tend to not like obvious losses. By dropping inscription, you openly accept that it was a waste. If you keep doing a sub-optimal thing (working with lot of glpyhs for low G/week), you don't have to face with the loss. This is why it's hard to get rid of the 1c campers. It takes couple of weeks until they suffered enough to accept "defeat".

So social people keep throwing good money after bad, suffering high losses in invisible opportunity cost, rather writing down a one-time visible loss. You can use it against them, by dragging them into an investment with lies. After they are inside, they won't back off.

The same way, whenever you are about to make a decision, write down on a piece of paper all future costs and benefits. Without hard data, the ape-subroutines in your head add the already sunk costs to one of the options, forcing you to choose that one.

22 comments:

Kraklin said...

I believe there is a hidden "profit" from lessons learned leveling up inscription and learning the market. Even if you end up dropping the profession.

I expected much more profit from inscription, but with too many AH campers I've decided to just mass post at 4g then go do other higher gold making professions on my DK alt I made while hoping that those competitors get frustrated with low profits (that they have to constantly log in to AH camp)

I think you need to set your own "rate", whether that's 1,000g/hr, 5,000g/hr.. I know at 2g 50s profit per glyph I'm at around 800g/hr, just above gathering professions.

So I prioritize my time on higher gold/hr professions like JC/ench then get to inscription activities after those are covered and maximized.
All depends on your server which profgives most gold/hr or gold per week profit.

Anonymous said...

Okay let's take a look at it.
You can make a small profit and wait a few weeks to figure out how to beat this guy. You can also just invest 2k gold with the risk of meeting another 1 copper AH camper in that profession. What are you gonna do then? Invest 2k and level another profession?
Or what are you gonna do when such a guy happens to get in your inscription market this way?
You're gonna lose big money if you just level another profession every time you're having a little bit of a hard time with a profession. Of course, if you're stupid enough to wait 6 months it's time to accept your loss and level another one. However, if I have 3 bad weeks I won't just level another profession. I would lose way too much money with that, not to talk about how much trouble leveling a profession can give you with some materials being just not available.

Sven said...

Gevlon

I fully agree. Sticking with failed projects "because we've invested too much to fail" is a big problem IRL as well. In that case, there's an additional pressure. Having sat in lectures when the principle of sunk costs was explained to senior managers from various companies, it was clear that they didn't accept what they were being told. Why? Well because abandoning a project means admitting that it was a failure and hence a blot on the CV and, in extreme cases, dismissal. Sticking with it until it makes at least a minor profit (even if there are better profits elsewhere) carries no such risk.

Of course, it should be the other way around, but their managers in turn don't accept the rule of sunk costs, so it isn't in reality.

This is a very common example of where the rational thing to do for yourself (accepting that your boss doesn't believe the sunk cost rule, no matter how irrational that belief is) is very different from doing the best thing for your employer (writing the loss off & starting again).

Fortunately most Goblins in WOW are independent traders, so aren't subject to the same pressures. If you stick with sunk costs in WOW, there really is no excuse.

Anonymous said...

@Other Anonymous

You seem to miss the point of this post, which is: to make a decision wether or not to drop a profession, don't look back at what you've already put into it since you can't get it back anyways.

Compare it to a car you buy that guzzles down 50 Gallons to the mile when the new hotness car comes by that only uses one gallon for 50 miles ... you can keep driving the 50 Gallons car since you put in so much money to buy it, but in the long term, it'll end up costing you more than the 1 gallon car.

Gevlon said...

@Sven: managers (as opposed to owners) are not surely wrong refusing to accept failure. Their "profit" is their salary and their reputation, NOT the company profit. They most probably completely aware that they are harming the corporation, but hey, that's not their problem!

Anonymous said...

I get the point of the post, and if you need to drop it, drop it, but what I'm trying to say is that dropping a profession too fast can cost you dearly. So I can understand why people wait for a while. Of course, when the profession isn't gonna make you much money, drop it, and don't look back. In that case it's just a bad investment, such as we all make sometimes.

Sven said...

@Gevlon

Again, I agree. However, when this attitude runs all the way to the top (as it often does), it does harm organisations, when even those who *are* responsible for looking after shareholder interests (and even the shareholders themselves) hold the same view.

Heavy B said...

Being an altaholic, it won't harm me much if one profession failed or at least made minimum profit.

I currently have 9 70+ characters 3 of them level 80s one soon to be.

I have ALL professions. They are all either at max or 400+.

Inscription for me is currently at minimum profit because of lowblowing competitors posting glyphs that cost 2g for materials (cheap mats in m realm) at 50-60 silvers, apparantly they are either stupid enough to post them at loss or they are trying to drive out competitors, so when they are not there or I have glyphs that they don't have I make profit. Otherwise I keep the glyphs at bank if they won't make profit. I tried buying them out but they keep on coming.

I just recently focused on making gold. So far so good. But the road is a bit long and bumpy before hitting the cap.

Anonymous said...

Maybe a touch off topic, but why is it I never hear about the cards that can be made from incription? Do the cards and decks from inscription not make good gold?

Anonymous said...

Depends on your business model.

Most glyphrs will sell Snowfall Ink to pay for the price of the ink of the sea.

On my realm you can buy a stack of herb for 22g, snowfall sells in the range of 15g to 20g... hence the ink of the sea I'm getting from a stack of herb are costing from 0g to 1g a piece depending on the snowfall proc.

Of course it can happen that too many snowfall inks hit the AH at a single time making the price drop.

In that case it might become interesting to turn your snowfall inks into darkmoon cards to dump your stock at a profit.

Anonymous said...

About the cards:
I don't think you can much gold with it. This is because of one simply thing: if you buy one card you have one trinket. If you buy two cards you have two trinkets. You don't need more then two(why anyone would want two is not up to me). So everyone who buys one or two cards is one customer less. Although there are more then enough customers, there are not so much customers with enough money to buy them. So your market is pretty small.
Glyphs usually are not very expensive, easily replaced with a respec or second spec. This makes them a more wanted item. That makes glyphs sell more then cards and allows mass production of them.
I think you can make some money with the cards, but you won't be able to beat the earnings of glyphs.

Anonymous said...

The key bit to understanding the concept of the post to me is this:
You must evaluate all costs and benefits of your actions. If it costs you 2000g to level inscription, and you can make 100g a week (after expenditures) from it (random number), you will take 20 weeks to start showing a profit, and after that you will have a profit of 100g a week. If you switch to another profession you are 4000g in the hole, however if that profession can make you 200g a week you break even in 20 weeks, and then start making a profit of 200g a week. Yah, it hurts at first, but in the long run going with the higher profit just works.

Admittedly, I don't follow that advice and work more along Kraklin's idea. If something isn't making me money, I just don't spend the time on it. Instead I back out of the market, let whomever is mucking about do some, and come back when it is more in my favor. It is the advantage of WoW, there are no storage or spoilage costs (outside of depreciation of materials), so if you are dealing with some one who is listing goods at a loss, or constantly undercutting, your best bet is to just not waste your time, step out, and come back when they are off guard or have gotten tired of it.

My current amusement is watching the 2 people that can make shatter rounds on my server undercutting me (who is listing 100 stacks a few gold below their top price) and each other constantly. I will be stepping out of the game for a few too see what they do.

Nielas said...

As already mentioned WoW does allow you to 'have your cake and eat it too' when it comes to professions that turn unprofitable. A profession you already skilled up in will not degrade over time so one can just 'mothball' it and learn a new profession on an alt.

The 'sunk costs' idea still applies but it does not have to be a loss, just a zero-profit 'inventory'.

Paul said...

Why would you drop a profession that requires months of daily research to get a full crafting book when you can just create an alt and pickup a new profession?

Charlie said...

This example is slightly confounded because dropping a profession is both irreversible. Inscription also takes an investment of months to discover all of the glyphs. Inscription markets (at least on the servers I've leveled it on) fluctuate quite a bit from month to month. Also, the impact of a single hardcore camper can have a drastic effect on your profit.

The thrust of this post is spot on: sunk cost is sunk. If you spent all your gold on something worthless, your investment doesn't magically make it valuable.

Maybe a better example would be a bank full of frozen orbs purchased before 3.3. On my server, I now regularly buy them up for less than 5 gold and vendor them. If you bought up thousands without realizing that they'd tank, your best decision would be to clear out your inventory and use the (diminished) gold for something profitable.

Anonymous said...

@Paul
1) The assumption is that they have just gotten their inscription to max, and haven't started in on the researches (or at least not much).
2) Don't have time/inclination to level an alt to whatever it is we need to max a profession these days.

Number 2 being the main one I think.

Tonus said...

This makes me think of some of the people who have lost large amounts of money to Nigerian "419" scammers (the ones promising a massive payoff if you'll just send them some money first). The idea behind the scam is to keep stringing the 'target' out. There is always a new obstacle that requires an additional $1,000 or $5,000 or $20,000, etc.

Many of the targets admit that it did not take long for them to believe that it was a scam, but that they held on to the hope of getting the money because they had already spent so much of their own. That, plus the shame and humiliation that would come when their family and friends discovered the scam, kept them from ending their involvement, even when they understood that they were simply flushing money away.

Or to put it a different way, not every sunk cost is measured in currency.

Nielas said...

@Anonymous
The cost of leveling a new alt to where he can max out a profession is that of leveling a DK from 55 to 65. So Your Mileage Might Vary as to which is a better investment.

Anonymous said...

One nice thing about WoW is there are no "idle" costs. IRL, if build a factory to make a widget. If the become unpopular or unprofitable. You can't really afford to "idle" it in hopes that they become worth making again.(taxes ,maintenance ,etc). Your options are rebuild or try and make a profit with widgets. In WoW you can build another factory(toon) right next door for minimal cost say 3-3.5k gold instead of 2k for a "rebuild". Now that first factory can sit there empty until you check widgets a year later and find out you can make a killing just by turning on the lights...

Klepsacovic said...

No one likes obvious losses.

There is benefit from the idea that he gold is not lost yet, and by doing so, accounting for it twice: it promotes caution when making large investments. The means that next time the player will be not thinking, "Where can I get some quick gold without much work?" since that's what created his problem in the first place. Instead he will ask "What is a good use for 2000g?"

In this single situation, the costs are lost. However if accounting for them twice prevents future mistakes, then this sort of thinking is a net gain. Obviously the ideal is to take each situation in proper context and consider each one rationally, but that's asking a lot.

Orcstar said...

In a follow up: always re-evaluate the costs of your materials, your stock.

They're never worth what you bought them for they're worth the current market price.

If you bought inks for 3 gold some time ago. And now inks are 2 gold. Selling a 2 ink glyph for 5 gold is still a profit. (you need to be more careful with your long term investments though)

Apple computers priced themselves out of the market this way. They bought millions of memory chips for a high price in 1988 expecting a shortage. But by the time they sold their computer with those chips, the shortages had vanished and prices of memory chips had sharply decreased. But Apple refused to calculate in low memory prices and had expensive computers. So they lost the battle with the IBM based pc-market which sold cheaper computer because of cheaper memory chips.

Sven said...

There's a good article on this very topic at:

http://www.psychologyofgames.com/2009/12/30/duke-nukem-forever-escalating-commitment-and-chewing-bubblegum/