John is a web designer. He owns a small web design company and carefully considers the cost of labor, especially outsourced jobs, when he bids on a new website project. Sometimes, to save money, he’ll do most (if not all) of the work himself, especially on smaller jobs. He makes a profit most of the time.
John’s a great web designer, but his real value is in networking – people enjoy talking to him. He’s found that when he goes to a potential customer and personally delivers his pitch, he usually wins the bid.
What’s wrong with this picture?
If you guessed that John isn’t considering his lost sales time when he does the design labor, you’re right. The concept is called “Opportunity Cost.” Thomas Sowell defines this cost as, “What you’re giving up in order to get something else.” In John’s case, every time he does the design labor himself, he’s giving up time he could have spent bringing in new business. How much business do you think he missed out on because he was too busy doing the design work?
Small business owners sometimes have a mental block when it comes to the cost of their own time. It happens all the time: an artist sells for $25 a product that took 10 hours to create, making his time worth $2.50/hour. A contractor will travel 50 miles to bid on a small job that will pay enough to cover the travel expense, but not if she adds in what her travel time is worth (many business owners don’t pay themselves so they don’t consider the cost of their time).
But opportunity cost is more than just the cost of time; it’s the cost of whatever else you could be doing with that time. What could the artist do instead with the 10 hours that might be more lucrative; what could the contractor have done with her time that might have generated more money in the long run?
Opportunity cost is not just about time; it can be about investment money. If John the web designer has extra money, he could either invest in a new computer that would speed up his design process or a new employee who could double his design output. The cost of the new computer is the lost revenue that he could have gotten if he hired a new employee.
One last aspect to consider is the opportunity cost of a small business owner’s happiness. When an owner makes a decision that will benefit his business but create more stress, what is the opportunity cost of that decision? Will it lead to less stress in the future, or will it lead to a less healthy lifestyle? Bottom line: there is a hidden cost to every decision a small business owner makes, and considering that cost now means fewer surprises and more satisfaction.
(Source: Alisa Kirk, Area Director, UGA SBDC at Clayton State University)