Beware the sunk cost fallacy in a post-pandemic worldby
As we emerge out of lockdown into a post-pandemic world, Kevin Philips considers what this means for the economical future of business and industry.
I live in a city that, in years gone by, was a major tourist destination for local and international visitors, especially during the summer months. Inevitably, restaurants would hike prices at this time of year, and, certainly, demand was high. The city was busy, people were in a holiday mood, end-of-year bonuses had been paid, the exchange rate was favourable, and waiting lists for tables were long.
But, come the end of summer, all too often these tourist prices would remain. And each year you would see the same thing happen: the go-to place for the last season or two would disappear after a few slower winter months. These typically were the restaurants that would hang on to that festive season premium, instead of adapting to a changed situation. On the other hand, restaurants that acknowledged their local, all-year-long clientele with winter specials typically stayed around, year after year.
It seems like we face a similar situation now, as a post-pandemic world slowly becomes a reality. While currently many commentators seem bullish about a fast post-pandemic bounce back, and even boom, this is unlikely to be consistent across countries, industries, and population groups. Just as the pandemic affected different groups in different ways, the recovery is likely to be patchy, depending on vaccination schedules, for a start.
Will industries that boomed during the pandemic, for instance technology, home improvement and home delivery services, maintain their trajectories, see a correction, or experience a crash? Further, what will the recovery for industries that were decimated by the pandemic, such as travel, look like? In both cases the world has changed substantially since 2019, and as I’ve written previously, using recent data as a predictive tool should be treated with caution.
The sunk cost fallacy
Today, at an individual company level we each have a choice to make as we consider our post-pandemic strategy. Do we succumb to sunk cost thinking and try to make up our pandemic losses quickly? Do we cut costs, raise prices, gouge our customers, and exploit our people?
Or do we take the approach of treating what has gone before as history, and what is in front of us as a new paradigm that requires a fresh outlook? With this approach, we ignore retrospective costs as no longer relevant in our decision-making. They’re water under the bridge and to take them into account means we misallocate time, effort and resources going forward, because we are factoring irrelevant information into our decision making. Economists agree that avoiding the sunk cost fallacy is the rational approach to take.
An example of this approach is the stock market. Do you stick it out with an under-performing share in order to hopefully recoup your losses? Or do you write-off your losses on that specific share and redeploy your funds on better performing opportunities where you can not only recover your initial losses, but also see additional future growth?
This highlights the second downside to sunk cost thinking. Not only does it involve acting on irrelevant information, it comes with a massive opportunity cost. If we are so fixated on looking backwards and recouping our losses, we miss out on the opportunity to explore new growth opportunities looking forward by changing our approach for the current reality and areas of growth. You could summarise this as the difference between an austerity mindset and a prosperity mindset.
Take the travel industry. Undoubtedly it was one of the hardest hit sectors during the global lockdown. But once the pent-up demand for travel is unleashed, the industry will no doubt experience a very welcome upswing. And as with my local restaurants during winter, these businesses have a choice: write off their losses and look to the future to grow a thriving business in the long-term, or, make their first visitors pay for the losses over the past year.
Starting with a clean slate and resetting our mindset enables organisations to react to today’s circumstances and today’s customers’ requirements. This is not that different to how a salesperson starts each year — the counter goes to zero and targets are reset. This approach takes a realistic look at upcoming costs and the potential for sales, looks at what the product is worth, and sets targets and pricing accordingly and realistically. To be sure, to do this you need your finger on the pulse of your organisation, with real-time insights into trends, predictions, and expectations relevant to your current circumstances.
Perhaps this rational, prosperity mindset will become a self-fulfilling prophecy, driving growth today, tomorrow and into a possibly uncertain future.
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Kevin is the founder and CEO of idu Software. He has degrees in Commerce and Accounting, and started idu with partners James Smith and Wayne Claassen in 1998. Kevin is fast becoming a thought leader in his field, and makes regular comment in the media about current affairs affecting business, as well as accounting, finance, budgeting and...