Sunk Cost Fallacy (The Leaky Boat Principle)

The Sunk Cost Fallacy is the cognitive bias where individuals and corporations continue to invest money, time, or effort into a failing project simply because they have already invested resources in it, even when better alternatives exist.

In Berkshire's history, the definitive case study of the Sunk Cost Fallacy is the twenty-year struggle to save the Textile Operations, which was finally shut down in July 1985.

🧬 The Core Argument

• Emotional vs. Rational Allocation: Buffett admits that his decision to keep the New Bedford textile mills open for two decades was driven by heart (loyalty to workers and the community) rather than intellect.
• The Capital Trap: In a commodity business like textiles, each capital investment program looks rational in isolation because it promises to reduce costs. But because all competitors make the same investments, the cost reductions are passed on to customers as lower prices. Thus, the industry reinvests vast sums of money only to maintain anemic returns.
• Vessel over Rowing: A manager's economic results are determined far more by the fundamental economics of the industry they enter (the "boat") than by their skill or work ethic (their "rowing").

📍 The 1985 Textile Post-Mortem

In the 1985 Letter, Buffett provides a detailed autopsy of the textile operations:

• The Initial Investment: When Buffett Partnership, Ltd. took control of Berkshire in 1965, the textile business had a book value of $22 million but very low intrinsic value.
• The Liquidation Reality: The equipment, which had a original cost of $13 million (and replacement value of $30–$50 million), was sold at auction for gross proceeds of $163,122. Loom machinery purchased for $5,000 in 1981 was sold for scrap at $26 each (less than the cost of removing them).
• The Contrast: Buffett notes that the economic goodwill of a single See's Candy shop or two paper routes in Buffalo far exceeded the liquidation value of the entire New Bedford factory complex.

🗣️ Primary Source Quotes

"I ignored Comte’s advice—'the intellect should be the servant of the heart, but not its slave'—and believed what I preferred to believe... My conclusion from my own experiences and from much observation of other businesses is that a good managerial record (measured by economic returns) is far more a function of what business boat you get into than it is of how effectively you row... Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks." — Warren Buffett, 1985 Letter

"A horse that can count to ten is a remarkable horse—not a remarkable mathematician. Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company—but not a remarkable business." — Warren Buffett, 1985 Letter

🔗 Connections

• Source: 1985 Letter
• Concept: Making It Back The Way You Lost It
• Concept: Capital Allocation
• Concept: Commodity Business Economics
• Entity: Rose Blumkin (Mrs. B's asset-light success contrasted with textiles)
• Index: index