What is Durability Bias?
Durability bias is the subconscious inclination to forecast past events or occurrences forward to the future. In other words, durability is a type of cognitive bias with the assumption that past trends will continue into the future. The term durability bias is commonly used in behavioral finance and forecasting.
Implications of the Durability Bias
The durability bias can have a significantly adverse effect on decision-making for investors. To illustrate the point, imagine an investor who believes a company that has regularly outperformed analyst estimates for Earnings per Share (EPS) will continue to do so indefinitely. Imagine then that the competitive landscape in an industry changes, and the company doesn’t alter its business model in response. Over time this company would start underperforming and prove to be a bad investment.
In this example, using the past as a reference for the future was not a good idea. Instead, an investor should look forward to what may happen in the future, independent of the past.
Example of Durability Bias
US markets are seeing significant growth, with stocks yielding unprecedented returns due to a booming market and expanding economy. John is a retail investor and current business student who recently took an interest in investing. He notices the impressive gains in a stock called “CFI,” which has seen a price surge of 15% year-over-year. John concludes that if he invests $10,000 in the stock today, given the year-over-year gain of 15% on the stock, he will end up with $20,000 in five years’ time.
In the example above, John is exhibiting durability bias. He assumes that since the stock of CFI has seen a gain of 15% yearly, it will continue to do so into the foreseeable future. The truth is that the past performance of the stock is not necessarily indicative of future performance.
Case Studies of Durability Bias
Listed below are two well-known companies that failed to innovate or change their business model in an ever-changing business environment, which was attributed to durability bias, leading to their demise:
Founded in 1985, Blockbuster was one of the most iconic brands in the video rental space. Blockbuster, at its peak, employed over 84,000 people worldwide and boasted over 9,000 stores. The company, blindsided by its success in the video rental space, failed to transition towards a digital business model and filed for bankruptcy in 2010.
Ironically, Netflix approached Blockbuster in 2000 with an offer to sell their company for US$50 million. However, the CEO of Blockbuster thought that Netflix was a very small niche business. Today, Netflix counts over 100 million subscribers worldwide with revenue upwards of $9 billion.
Toys R Us
Founded in 1957, Toys R Us was a world-renowned toy store chain. In the early 2000’s, Toys R Us was doing extremely well in its brick-and-mortar stores. But even with the emergence of e-commerce companies such as Amazon, Toys R Us decided to stick to its traditional business model and not pursue an e-commerce presence. Toys R Us missed the opportunity to build up its own e-commerce platform, and as a result, the company filed for bankruptcy in September 2017.
Durability bias can exert an adverse influence on both investors and businesses. Companies and individuals who are able to avoid the durability bias constantly question future growth rate assumptions. Companies that are caught up in the durability bias and do not alter their business models in a changing environment are subject to failing.
Thank you for reading CFI’s explanation of Durability Bias. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
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