Opportunity Cost

Unlimited wants limited resources.  That pretty much sums up economics.  It is the fundamental truth you will face every day in your own business. 

Everything costs something.  But it is not ten dollars or a thousand dollars. The cost is what else you could be doing with your time and resources.  Most businesses have to choose between producing product A or product B.  To produce product A they have to give up the opportunity of producing product B. Economists define the "opportunity cost" of any good or service as the value of all the other goods or services that we must give up in order to produce it.

We automatically make decisions based on ‘opportunity cost’ all the time.  You can stay home and read a business article on the Internet or you can go for a walk in the woods.  By doing one, you are giving up the opportunity of doing the other.  To decide which to do you need to put a value on each activity.  A numerical value makes it easier to make comparisons.  In the business world, this numerical value is called ‘money’.  When a salesperson tells you the price of a product, you compare the price of the product with the value of the product.  If the price is less than or equal to the value then you buy the product.  The more information you have the easier it is to determine a value.  In the example above, both may start with equal values.  When you hear the weather forecast or learn the article was written by Herb Wexler the values may change. 

You will find many high priced products have little or no value to you.  Likewise, there are low-priced products that may have great value to you.  This just means that the products are priced for people who have different needs than you do.  You probably dance to the sound of a different flute.

When comparing prices and value you must also be aware of the time value of money.  A dollar today is not worth the same as a dollar a year from now.  If you can invest your money at 6% then a dollar today has a future value of $1.06 in one year.  Likewise, a dollar a year from now has a present value of $0.94.

When deciding which products your company will sell you need to understand both the concept of opportunity cost and the time value of money.

Profit (Revenue - Expenses)

 Year 1Year 2Year 3
Example 1

Product A

10,000 

10,000 

10,000 

Product B

6,000 

6,000 

6,000 

Example 2 

Product A

10,000 

10,000 

10,000 

Product B

6,000 

8,000 

50,000 

 Example 3 

 Product A

10,000 

10,000 

10,000 

Product B

 9,000

9,500 

9,900 

In example 1 it is easy to see that product A is the better choice.  Sure, product B brings in revenue but the opportunity cost is giving up the revenue of product A. Example 2 is trickier.  If you look at the short term it makes sense to go with product A but if your projections are correct and not wishful thinking then product B makes the most profit.

From a pure analytical viewpoint product A in Example 3 is the one to base your company’s future on. However, if you and your staff are passionate about product B then B is the better choice. Passion unlocks resources that are difficult to quantify.  People work harder with more creativity, it is easier to attract and retain employees and most importantly, customers can see the passion.

Decision-making requires both passion and analysis.  You cannot run a successful business without firm facts and analysis.  As a manager/business owner, you must also recognize the value of passion. This is another way to prevent mediocrity.


Follow the path of the unsafe, independent thinker.  Expose your ideas to the dangers of controversy.  Speak your mind and fear less the label of 'crackpot' than the stigma of conformity.  In addition, on issues that seem important to you, stand up and be counted at any cost. -Thomas J. Watson 

Some people think only intellect counts: knowing how to solve problems, knowing how to get by, knowing how to identify an advantage and seize it.  But the functions of intellect are insufficient without courage, love, friendship, compassion and empathy.  -Dean Koontz 

It's choice - not chance - that determines your destiny.  -Jean Nidetch 

If you limit your choices only to what seems possible or reasonable, you disconnect yourself from what you truly want, and all that is left is a compromise.  -Robert Fritz 

Quality is never an accident; it is always the result of high intention, sincere effort, intelligent direction and skillful execution; it represents the wise choice of many alternatives.  -William A. Foster 

Good plans shape good decisions.  That's why good planning helps to make elusive dreams come true.  -Lester R. Bittel, The Nine Master Keys of Management 

Making a wrong decision is understandable.  Refusing to search continually for learning is not.  -Philip Crosby, Reflections on Quality

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