How many tough decisions have you made this past week?
If you’re starting up or running a company that number is most likely immeasurable.
When you’re presented with two or more viable options for making a decision, yet you had to stick with just one and miss out on positive potential results, then you’ve experienced the effects of “opportunity cost.”
Every decision involves a series of potential outcomes. When you make a decision, you are actively choosing NOT to pursue other alternatives. We all hope that the decisions we make will pay off, and will be the best possible outcome but that’s not always the case.
Sometimes the opportunities we did not take, have some positive potential outcomes that need to be weighed out, we’ll be chatting about that concept below!
So What is Opportunity Cost Anyways?
Opportunity cost is a term related to the cost of the alternative potential positive outcomes when making a decision. We often weigh out our options when making decisions, and the opportunity cost is the potential loss of a positive outcome of the options not taken. It’s what you miss out on by not making that choice.
No decision is truly black and white, so there is always potential for there to be a positive outcome from a potential decision. The loss of that potential positive outcome from the option you didn’t decide on is your opportunity cost.
This is essentially the opposite view of risk. Risk is the potential negative effects of a decision and can tend to be a little easier to think of. Opportunity cost is a much more positive way of looking at options but they go hand in hand.
Here’s a little formula for better clarity
Opportunity cost= The potential benefit of the option NOT taken/ Best potential outcome of option taken
It’s an economic term typically and often relates to investments or monetary returns, but its relation to the entrepreneur’s world is undeniable.
Why is Opportunity Cost Important For Business Decision Making?
You don’t operate in a void. Every decision you make has an effect and those potential outcomes should at least be thought through before a final decision is made.
Decision making for entrepreneurs is especially important because the weight of our decisions impacts much more than just ourselves. There are customers, team members, employees, and fans that can all be impacted here directly or indirectly. Their viewpoints should be taken into consideration.
How to Use Opportunity Cost in Decision Making
This may be something you do already, and if so, you’re a natural entrepreneur. But if not, then it just takes a bit of conscious thought in order to conceptualize potential options and their positive outcomes down the line.
This means thinking of options not by their immediate impact, but by what could happen when this decision is perceived by others and how they may respond. It’s more long game. If you’re a Game of Thrones fan, think Varys or Little Finger. They tended to make decisions and move based on much longer term goals and were able to remain steps ahead of others (until they weren’t, but let’s not get into the risks involved in that show).
There is no real way to know the future of course, but if you understand the situation, the options, the key players, and the other factors indirectly involved you’ll be better equipped to conceptualize the positive potential outcomes of all your options.
What’s the Worst That Can Happen?
When starting or running a company you are flooded with decisions to make, and that means there are a whole lot of variables and potential opportunities to take up or pass up. Consequently, there is an unimaginable amount of opportunity cost any given day.
This isn’t necessarily a bad thing, it’s inevitable. You can’t undertake all the opportunities that come your way in a day. In business you have to make decisions and stick to them. That means that there will always be potential positive outcomes from opportunities you didn’t take.
There are 2 fatal flaws entrepreneurs can make when using opportunity cost as a way to make decisions.
- The “Negative Nancy”- An entrepreneur here will think of every decision in terms of what they could potentially miss out on. This, typically in combination with lack of confidence, becomes paralyzing because they don’t want to miss out on ANY potential positive outcomes. This position is what I call the dreaded“ Potential Outcome FOMO” No decisions take place, and if they do, they’re half hearted or delayed.
- The “Know It All”- This is the entrepreneur who doesn’t factor in opportunity cost or risk in decision making at all. They’re very confident in their decisions and often make decisions based on knee jerk reactions. They like to move quickly and often make decisions entirely on their own.
Both of these positions can be killer for an entrepreneur because they either prevent you from making decisions entirely, or can result in disastrous unplanned outcomes.
To avoid these two fates, you must incorporate opportunity cost to some extent in your decision making process. You need to weigh these potential outcomes and consider the positive effects of all options. You need to find your happy medium between #1 and #2 above. Look at the potential outcomes, but be confident enough in your decision making and problem solving skills to know that you can handle whatever happens.
Entrepreneurship is a risky and challenging endeavor, keeping your thought process in check when making decisions is incredibly important. Find your balance, consider all your options and the risks and opportunity costs involved, but don’t harp on anything for too long. Be thoughtful but know your time is money. Consider all your potential outcomes, but move confidently in the direction of your choosing and carry on.