Opportunity Cost: Revolutionary Decision Making
The term opportunity cost revolutionized the way we make economic decisions. The word first hit the business scene in 1914, when Friedrich von Wieser published his famous work entitled Theorie Der gesellschaftlichen Wirtschaft; where he explored Social Economics; specifically how human behavior influences economic systems; i.e., decision making. Opportunity cost is defined as a benefit, profit, or value that is given up to acquire or achieve the other decision. What is so revolutionary about this concept is that it weighs other factors, not just money (profitability). When I was attending college at the University of Utah; I had the opportunity to take a graduate level course in Economics in Law. At the time most “But for” cases, under Tort Law, were calculated using accounting principles. “But for” are cases dealing with the damages (aka causation) due to someone else’s negligence. For example, they used calculations to determine what an “arm” is worth, in cases where the Plaintiff lost an arm while on the job. Now accounting handles present and past information for calculations, they forecast by using averages over that past and present timeline (“But for” is also used in infringement cases).
What we discovered is that these “But for” calculations were not as black and white as we once believed. Economics can account for other factors, for example being able to hug your children and loved ones completely. You see Economics was an answer in these “But for” cases, due to its ability to address the gray in these matters; in some cases techno-color.
Take this concept into your business decision making. I always found it fascinating that in the beginning stages of building a business individuals take higher risks; investing money, time, and resources to a concept or idea that had no guarantees to succeed. However, as the company grows and reaches levels of success, you see this behavior change. Now the mentality reverts to doing everything they can to hold onto money; using accounting to make business decisions. Not to say that accounting does not have its place; it is invaluable when dealing with present and past measurements, balancing accounts, taxes, interest calculations, and overall present-tense profitability measurements. Where we run into issues is during the forecasting, specifically in Market Expansion or Penetration. For those reading this and have either started a business from the ground up or assisted in building a business, knows this all too well.
So knowing that there are two mentalities, one viewing the business world as Black and White, and the other seeing the gray; how do we balance these perspectives? To understand this more deeply, we have to review the difference between Short-Term and Long-Term Thinking. Most of the businesses I consulted with were in some economic trouble; profitability being low or falling below the black. Accounting will look at the Black and Red; conserving resources due to lean times; while economics will look to long-term investments, using a calculated risk; opportunity cost to each business decision.
Being a business development manager for Professional Recruiters, I have seen this first hand; where Decision Makers were caught in short-term thinking; analyzing our service through the short-term costs of building a Top Level Team. So they attempt to go at it on their own, where internal recruiting efforts cost them in time and having difficulty reaching the Level of Talent that will make the impact to hit annual projections. Looking at decisions through the looking glass of opportunity cost will assist in pushing your mind to long-term thinking.
For example, if there is a Director Position that needs to be filled, and getting the Top Talent in the industry is the only way to execute an expansion plan; what is the opportunity cost you are foregoing a Top Level Recruiting Firm? Some factors to think about are the costs of maintaining a internal recruiting team, recruiting tools needed, time of Managers breaking away from duties to interview and review candidates, and the cost of reducing staff when times get slow; and none of these guarantee that the company will connect with the Top Performers in the industry. Now compare that to developing a Contingent Agreement with a Top Recruiting Firm, where if they don’t produce you don’t pay; no risks, no upfront fees, or hidden costs; how does your decision balance out? The bottom-line is that we cannot forget the mentality that made us successful in the first place. Reviewing your choices through the opportunity cost lens will provide you with a more well-rounded analysis.