Monday, February 25, 2013

Is Mark Sanchez a sunk cost?

As chapter 3 points out, when making decisions, there are only two mistakes you can make:

1. ignore hidden costs; or
2. take account of sunk costs.

The NY Jets football team are trying to avoid the second mistake in trying to decide what to do with their quarterback.  Mark Sanchez has

...played poorly for two seasons in a row, and has now thrown more interceptions in his career than touchdowns. But the Jets have invested an enormous amount of energy and money in Sanchez, and, assuming that no one will trade for him, they are contracted to pay him $8.25 million next year, whether he plays or not.
 In the Jets case, the relevant costs of keeping Sanchez or trading him should ignore the guaranteed salary and look at the alternatives.  It could be the profit they could earn by keeping Sanchez, despite his poor performance, are bigger than the cost of keeping him--the profit of the alternative.  The league is short on good free agent quarterbacks and the draft looks thin, so keeping him might be the right decision.

However, there are well documented psychological tendencies that might bias the Jets into keeping him regardless of whether it is the right decision.  
Hal Arkes, a psychologist at Ohio State University who has spent much of his career studying the subject, explains, “Abandoning a project that you’ve invested a lot in feels like you’ve wasted everything, and waste is something we’re told to avoid.” This means that we often end up sticking with something when we’d be better off cutting our losses—sitting through a bad movie, say, just because we’ve paid for the ticket. In business and government, the effect pushes people to throw good money after bad. The quintessential case of this is the Concorde. There was never a convincing business case for the supersonic airliner, and there were numerous attempts to kill it. But those attempts all failed, in large part because of the billions that had already been spent.

 Moreover the bias intensifies, the more you have invested:

The most intriguing aspect of sunk costs, as Arkes and others have documented, is that greater investment in a project increases people’s belief that it will succeed. That may help explain what happened last March, when the Jets gave Sanchez a contract extension that guaranteed his salary through 2013. Since Sanchez was already signed for two more years, and was coming off a mediocre season, the extension seemed peculiar to outside observers. But the Jets argued, and doubtless believed, that it was a smart way of locking up a young player. It was a classic case of what psychologists call the “escalation of commitment.” Since the Jets had bet big on Sanchez, it seemed reasonable to place an even bigger bet on his future.
HT:  Prof. David Murray

1 comment:

  1. A very nice article that I found that demonstrated opportunity costs with sports and how the decisions made can affect an organization or individual. The article discusses how decisions are made in major league baseball regarding player salaries, roster spots, and decisions to trade players. This scenario shows how even though it may seem like a team can give up a very good player for what seems like nothing, there is additional information that is made as well that may not be seen.

    The decision made was to trade a very good player who would cost a significant amount of money to the team, in order to get six additional players who were all good to their own accord but would cost much less money individually. The opportunity cost to this decision that was made was to keep the original player and bring in five additional players from the minor leagues who would have very minimal salaries. The team management obviously felt that it was more beneficial to have six good players, then one very good and five mediocre players.

    So it is very clear that there can be opportunity costs in just about every decision made, whether they are easily identifiable to those outside of the decision-making process or not. The key is to ensure that the decision that is being made is clearly the best of the options.

    Moffatt, Mike. “Baseball Players and Opportunity Costs.” Retrieved from