An associate professor at Harvard Business School recently gave the world an inadvertent lesson on opportunity cost when he spent several days taking a family-owned Chinese restaurant to task, to the point of threatening legal action, for an apparent overcharge of $4. (Happily, he has since offered a sincere apology.)
Opportunity cost is the loss of benefit associated with an option that is not chosen, given a set of mutually exclusive alternatives. In our restaurant example, the professor gave up not only the refund that was immediately offered to him but also the benefit of the myriad other things he could have done instead of composing those emails – from advancing his research to enjoying a nice glass of pinot noir. In the heat of the moment, it’s easy to overlook the possibility that what we’re doing right now isn’t, in fact, the most beneficial thing to be doing right now.
In my Value Consulting organization, we spend a lot of time with insurers exploring the value of transforming their business with a modern software platform. But recently, we’ve had some really interesting conversations focused on the converse of that: What is the opportunity cost of not moving forward? What is the cost of doing nothing? What is the cost of delaying a decision?
Let’s imagine that you’ve built a case for change in your organization. You’ve estimated that your company could realize a benefit of $12 million a year, beginning at the conclusion of a two-year project that will cost $25 million. But, with limited budgets and scarce human resources, approval for that $25 million could be a long way off.
Overcoming the big-ticket anxiety is difficult, but the math is pretty straightforward. In this simplified example, the investment pays back in year five, with a 10-year net present value of $31 million. So a choice in favor of the status quo will hurt your company by a net of $31 million over the next 10 years. Allocated evenly, that’s a loss of $8,500 per day – every day, including weekends and holidays – for the next 10 years. A six-month delay in moving forward will cost you $1.5 million. In the time you’ve spent reading this blog post, you’ve already lost 20 or 30 bucks.
Of course, an opportunity cost calculation is no guarantee that you’ll actually realize that benefit. The business case must be strong and realistic to begin with. The right software must be chosen, and the right decisions must be made during implementation to ensure success. The hard work of implementing the project must be done. But sometimes a simple, potentially cheeky data point is enough to start a much bigger, more serious conversation.
