Opportunity Cost

Overview: Opportunity Cost

The opportunity cost of any decision is the value of the best alternative you don’t choose. It is referred to as a cost because it’s what you are giving up.

Opportunity cost helps us make good decisions by understanding the true costs of each alternative. Here are some questions that help us think about opportunity cost:

What else could we do with the time we’ll spend on this?
What’s our next best alternative?
Besides financial costs, what else will this cost us?
What if we do nothing?
Ignore what we’ve already spent on this, what will we give up to continue working on it?
What else could we do with this resource?
Is the reward worth the work?

Like many of our principles, opportunity cost is most helpful when applied alongside other aspects of good thinking– especially asking good questions.

Applying Opportunity Cost

Below are examples that contrast opportunity cost with other ways of thinking that are not grounded in good economic thinking principles. They don’t give you the “final” or “right” decision. As you read through these examples, think about how different answers to the opportunity cost questions might change the final decision.

Habit

Budgets

Sunk Costs

The Status Quo

Opportunity Cost vs. Habit

We often form habits or routines because they help us be productive. However, asking questions about opportunity cost can help you identify when a routine activity isn’t productive.

Scenario: A shift supervisor has a daily 15-minute shift meeting.

Thinking about opportunity cost	Making decisions on habit
What else could everyone be doing if I cancel today’s meeting? What could I do if I weren’t preparing for this shift meeting?	I need to find more topics to fill up the time. Only a few people need to hear X, but I’m going to say it in the shift meeting since those people will be there.

Wrap Up: Considering opportunity cost helps you to look critically at routine activities. This example doesn’t suggest shift meetings or recurring meetings should be canceled. Instead, it’s a reminder to stay flexible and recognize that benefits and costs of things like this will change.

Opportunity Cost vs. Budgets

In this example, notice that opportunity cost can include financial costs, but it should expand our thinking to also include non-financial costs.

Scenario: You are attending an event. The parking lot closest to the venue costs $20, the further lot costs $10, and there’s a free lot even further away.

Thinking about opportunity cost	Focusing only budgets or money
“Is it worth $20 to save the time and effort of walking so far?” What else could we do with the money we would save if we parked in the furthest lot? How much time do we have before the event starts? Will we miss part of the event?	What’s our budget for parking? What’s the cheapest option? We had $10 in the budget for parking, so we’ll use the $10 lot.

Wrap Up: Thinking about opportunity cost allows you to consider tradeoffs. And since circumstances change, it helps you optimize. The question, “Is it worth $20 to save the time and effort of walking so far?” would have a different answer if you have a sore ankle or if it was a nice day for a walk. “What else might I do with this money?” could be different if it’s an event where you want snacks versus a conference where the meals are included.

Opportunity Costs vs. Sunk Costs

Opportunity cost can be contrasted with sunk costs. Sunk costs are unrecoverable past expenditures. Sunk costs are backward looking -- based on decisions that have already been made and resources already used.

Scenario: It’s time to review a vendor contract. The team has had a relationship with the vendor for 10 years.

Thinking about opportunity cost	Fixating on sunk costs
What innovative technology might we miss if we don’t explore alternative vendors? What kind of time and effort will it take to seek and evaluate alternatives? If we go with a new vendor, what product features or services will we be giving up?	We've spent so much time and effort building this vendor relationship, we would be crazy to switch now. We’ve already done all the legal review for this vendor. Considering a new vendor would slow us down. We’ve done thousands of dollars of business with this vendor. It seems reasonable to keep working with them.

Wrap Up: It could be the right thing to do to stay with a current vendor; however, we need to avoid sunk cost thinking and instead use good economic thinking to choose the best alternative going forward.

Opportunity Cost vs. The Status Quo

Pausing to think about opportunity cost can help you identify when something different might need to happen instead of doing what’s comfortable or well-established.

Scenario: A project has gotten behind and the team is concerned they won’t hit a deadline. They’ve come up with three alternatives (1) work a lot of overtime, (2) cut some features they promised to deliver, and (3) ask for help from other teams, which would mean pulling people from other projects.

Thinking About Opportunity Cost	Defending or Relying on the Status Quo
How will each alternative affect our working relationships? What else would the team members be working on instead of this? What do we lose if we don’t deliver on the features we promised?	What have we done in the past? What’s the usual process? Let’s do what the best practices tell us to do.

As the team debates what to do, someone says, “As we’re talking through the costs and benefits of each alternative, I don’t like any of them. What would happen if we decided to miss the deadline or even move it?”

Wrap Up: It can be tempting to do what we’ve always done. Seriously considering opportunity cost helps us evaluate alternatives and even expand our range of alternatives.

What Now?

Any time you are faced with decisions, pausing and asking questions can help reveal opportunity cost. Understanding and considering opportunity cost is especially important when deciding how to use time – something that’s limited for each of us.

Give it a Try

The power of these principles happens through application. There’s no substitute for learning as you apply.