During a slow down, many businesses will cling to sunk costs and refuse to see the wisdom of bailing water!
A sunk cost is money spent—it’s gone, it’s sunk into something. Let’s say you get the idea that red baseball caps are sure to sell like crazy. You buy 500 of them at $4 each just ‘knowing’ you can sell them easily for $12. But they don’t sell. You have a sale, reducing them to $10 and they don’t sell. You try marking them down to $9 and they don’t sell. So, you really bite the bullet and mark them down to $7 and still no action. And now they sit on the shelf or in the stockroom.
You refuse to mark them down because “those things cost me $4 each and are worth a lot more than that”.
Here’s the bad news. An item or service is only worth what someone is willing to pay. Your cost has nothing with what an item is worth. The cost of delivery of a service has nothing to do with the value of a service.
Once the money was spent on our $4 caps, that cost was sunk.
Now what? Hopefully we learn from mistakes and make better decisions in the future. If you mark those caps to $4 and they still don’t sell?
At this point it’s time to get smart. I would raise the price back to the original $12 and start giving the caps away.
That’s right. If you display the caps at $12, they aren’t going to sell. They didn’t sell at $4. So let’s use the resource to promote goodwill. Advertising, promotions and give-aways all cost money. Here’s money already spent. By raising the price, we raise the perceived value of the gift. Who wants a ‘free’ clearance item? Giving the caps away with a purchase builds positive feelings about your business. It may generate more than actually selling the caps would have.
By ignoring the sunk cost and looking for the best use of the resource, you will get the most return from that resource.
Don’t misunderstand. You still use cost as your starting point when making decisions. Only a fool would buy the caps for $4 and then sell them at $3 without setting a higher price initially. But when items don’t move, you have to.
Another example is excess inventory.
When business slows down and you realize that you have 6 months of inventory in the stockroom, it’s time to sell down that excess even if it means dipping below cost. You must ignore the sunk cost and see that excess stock as a valuable asset to add new customers to your base.
If you see a new potential customer, give a deep discount to try your product line. You could give excess inventory as samples. And, a favorite of mine, you could have a contest to give away some of your excess.
When business is slow, use these tips to build your base. Far better to take a hit on a sunk cost rather than wasting [new] money on something silly like advertising.
Use what you have.