Every time we choose to pursue anything new, be it a business or a relationship, we pay for it with an opportunity cost. Opportunity cost is the benefit you could have received or achieved had you done something different.
Last week, I mentored a client looking to hire a marketing director and asked for my help to craft a job description that she could post. The client was also trying to finish developing her minimum marketable product. The exchange made me think about the role opportunity cost played in her decision to spend our mentoring time trying to come up with a job description so she could hire a marketing director vs. getting her minimum marketable product completed.
We can’t have everything we want in life; this is where scarcity factors in. We must deal with a limited supply of goods, services, time, money, and opportunities. The scarcity of resources is what drives our choices and, by extension, costs, and trade-offs. Every decision involves costs and trade-offs.
Whenever you say yes to something, you essentially say no to something else. The challenge with opportunity cost is that we often do not see the connection between the two things. As a business owner, whenever you say yes to a new opportunity or decide to do a task, you need to make a concerted effort to recognize what it is that you are saying no to or willing to forgo.
As a business owner, you make many decisions associated with opportunity costs. It might be as simple as choosing between spending the next two hours drafting a proposal for a new project or sending out invoices for some work that you just completed. What are the benefits of getting the proposal to the client today vs. the benefits of getting the invoices out? Each time we weigh the resources available and what to do with them, there is an opportunity cost of not pursuing one option by pursuing the other.
Failure to recognize opportunity costs often leads many business owners to say yes to too many opportunities. By saying yes to too many opportunities, you risk, at best, doing a mediocre job because you are spread too thin, or at worst, becoming overworked, eventually leading to total burnout or breakdown. As a business owner, you must understand the implications of saying yes to every opportunity and be highly selective.
When it comes to computing the opportunity cost, you need to consider not only the explicit alternatives, which are the choices and costs present at the time of decision-making, but also the implicit alternatives, which are the unseen opportunity costs. It requires thinking beyond the present, assessing alternative uses for your time and money, and not being shortsighted. Sometimes options that seem better from the outset are based on preconceptions that can lead to an inaccurate assessment of alternatives.
When assessing opportunity cost, it’s important to keep three things in mind:
The value of an opportunity needs to be assessed based on the benefits and associated costs.
Broader benefits should be assessed as well as the monetary benefits.
Each option needs to be assessed based on the same criteria and not in isolation.
Let’s say you are a web designer, and you have two contracts. Each contract will take you the same amount of time to complete. One will pay you $5,000, and the other $6,000. It might be easy to simply say that the $6,000 is a better opportunity to pursue. However, to really make a good opportunity cost decision, you have to look at more than the obvious.
What if the $6,000 contract paid you $500 a month for 12 months and was a maintenance contract for an existing website, and the other was $5,000 to create a new website that you could complete and bill out next month? Does getting $5,000 in one lump sum vs. only $500 monthly for 12 months change the opportunity cost? What if the $6,000 job had the option of being extended in the following years, each for $6,000 per year? How would that change the opportunity cost? Or how will each option affect your ability to accept future work?
Sometimes, opportunity costs force you to consider a non-binary solution. What if you accepted both contracts? Since you could not complete both projects alone, you might have to hire a subcontractor to help. How much time will it take you to find and hire a subcontractor? How would this alternative option affect your opportunity cost?
By looking at what would be lost by not seizing an opportunity, business owners can often find a solution to overcome resource scarcity at a cost that still might make sense. However, sometimes it is not viable or sensible to proceed, but by accurately assessing the opportunity cost, a more informed decision can be made.
Of course, at the genesis of many businesses, the business owner will often say yes to every opportunity because it is better than staying idol. However, as the business grows, the business owner needs to be more selective in accepting new opportunities. For every opportunity you agree to undertake, make a list of the things you will have to give up.
When it comes to assessing an opportunity, ask yourself the following three questions:
How much do I value this opportunity?
If I say yes to it, what will I have to give up now to have it?
And what will I have to give up in the future to have it now?
Do you have a process to calculate opportunity costs?
