Opportunity Cost

CONTENTS

What is Opportunity Cost
Examples of opportunity cost

What is Opportunity Cost

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Definition of Opportunity Cost

Opportunity cost is the loss of potential gain by selecting one idea or action over another. Whenever you choose to focus on a certain activity — be that a feature builds, software update, marketing campaign or new business venture — there are inherent opportunity losses. This could be measured in time or in money.

These costs are nothing to be afraid of. They are, quite simply, the cost of progress and moving forward.

However, if the opportunity cost of focusing on one activity outweighs the potential gain, then it could be time to reconsider.

Examples of opportunity cost

Opportunity costs are incurred all day, every day, whether we know it or not.

By deciding what to focus your billable hours on, there will be a ‘loss’ in the opportunity presented by something else. You simply need to weigh up which will deliver the greatest value in the long run.

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For example, by deciding to go freelance, your opportunity cost may be forgoing a stable paycheck, benefits package and company car. However, you may decide the value of a freelance set-up is greater than the loss of your 9 to 5.

In business, if you choose to reinvest profits into operations, that is money you cannot spend on marketing or paying dividends. An angel investor, upon deciding which enterprise to put his or her money into, will have to accept the cost of skipping over other investment opportunities.

As you can see, the opportunity cost isn’t necessarily a bad thing — despite its name.

General FAQ

How to calculate opportunity cost?

There’s no hard and fast rule on calculating opportunity cost, though it can still be approached in a mathematical sense if you want to weigh up multiple options ahead of making a choice. However, let’s use the example of choosing between Product A or Product B. Product A may have a higher cost of goods sold (COGS) but a speedy payback period, thanks to high forecasted sales and revenue down the line. Product B, on the other hand, is cheaper to produce but may not see the same market success. To calculate the opportunity cost of choosing Product A over B you must divide what you’ll sacrifice by what you stand to gain, e.g.: potential sales of A over B, minus COGS for A and B. Chances are, you’ll see that although a bigger investment upfront, Product A should be taken through to launch. The opportunity cost of choosing Product B is simply too big.

What is the opportunity cost of a decision?

The opportunity cost of a decision is what you miss out on by choosing to invest in one product, service, event, resource, etc. over the alternatives. Exploring opportunity costs helps you make stronger decisions based on identifying which options offer the highest value.

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Mastering Prioritization

Read now