Opportunity Costs

We are going to turn our attention on MBA Mondays to some costs that are important to recognize in business. First up is Opportunity Cost.

Opportunity Cost is the cost of not being able to do something because you are doing something else. These costs don’t end up on your income statement but they are expensive, particularly in a small business where you have very few resources.

Let’s use an example. Assume you have three software engineers on your team and you commit to building a new product that ties all three of them up completely for six months. Not only do you commit to build that product, but you sell it in advance and take a deposit from your customer to fund the development.  And then an even bigger opportunity comes your way. You have been invited to build a version of your product that will ship in a hot new device that a major computer company is making a big bet on. But you can’t take on that project because your team is tied up on the first project.

So the cost of the first project is not only the time and salaries of the three software engineers who are working on it. It is also the lost revenues and market share you might have gotten if you had been able to work on the partnership on the new device. That is your opportunity cost.

The problem with opportunity costs is that you can’t predict or measure them very well. They become painfully obvious in hindsight but not at the decision point when you need to know their magnitude.

So what do you do about opportunity costs that are out there but you can't see or measure? That's a tough one. I like what my friend Gretchen Rubin said on the subject:

I also try to ignore opportunity costs. I can become paralyzed
if I think that way too much. Someone once told me, of my alma mater,
“The curse of Yale Law School is to die with your options open” –
meaning, if you try to preserve every opportunity, you can’t move

So my advice is to understand the concept of opportunity costs, build them into you mental map, but don't focus too much on them. If you can, try to build some flexibility into your organization so you aren't completely resource constrained. That will reduce opportunity costs. But at the end of the day, you need to "move forward" in Gretchen's words and that is first and foremost what all great entrepreneurs do.

#MBA Mondays

Comments (Archived):

  1. William Mougayar

    Also, adding to your points- startups are so nimble that this allows them to react quickly and get around opportunity costs implications in other ways. I think opportunity costs are more critical for a larger or less nimble organizations where the reaction cycles are greater.

    1. Mark Essel

      Great point William, not having and(supporting) a thousand customers means the flexibility to develop a product for potentially millions.

  2. mrcai

    Seems like a good reason to keep your product simple and your engineers in the know. When that new opportunity comes up, hire more engineers and divide the original three between the two projects running in parallel. Then keep your fingers and toes crossed!

    1. Anthony Ortenzi

      I read about someone’s preference for using resources in groups of 12, because they can be evenly distributed among 1,2,3,4, or 6 tasks. I think it’s interesting to consider it the other way around — if you have relatively interchangeable resources which may scale up or down, organizing tasks into 12 equal groupings might simplify scaling up or down with people.

  3. LIAD

    Actuality occurs at the expense of potential. To bring something into reality you have to discard infinite potential options.Holds true for all areas of life.Young men find this incredibly hard – take marriage as an example.’how the heck can I settle down with one women, what about all the others I have to forego!’they don’t see marriage as gaining one real thing, they see it as losing out on 3 billion potential thingsIt takes a little maturity to realise that the only way you can achieve and create anything is by letting go of many others.

    1. fredwilson

      that is a fantastic analogy/comment LIADwell done

    2. Mark Essel

      It’s analogies like this that keep me writing.The art is seeing it.

    3. im2b_dl

      and along with that analogy… … the divorce rate is pretty high … ; )

    4. RWK: disruptive tech/guerrilla

      Alright already. Any female @fredwilson followers wanna get married?

      1. LIAD


      2. Tereza


      3. ShanaC

        Not yet and I have a type, thanks for asking!

      4. Donna Brewington White

        I can sign you up for my Geek Grooms matchmaking service. An idea whose time has come.

    5. reece

      right on, LIAD. the idea of opportunity cost is greatest used in life where the metrics aren’t really clear.

      1. Mike

        Might be why so many people view blogging as a waste of time (and commenting even more so). It’s almost impossible to measure any perceived value in the short run and it can be quite time intensive.Of course after spending a couple of hours this morning in JLM’s office, who I met through the comments section of this blog, I naturally disagree with that thesis.

        1. reece

          well said.

        2. David Noël

          I want to meet JLM too!

          1. Tereza

            OMG Mike got to meet JLM??!?!?Celebrity sighting!!!

          2. Guest

            HA! I wanted to say the same since a few entries ago but I could not dare. JLM, if you are ever in the city, I guess you have a small crowd to grab a cup of coffee with. 🙂

          3. Tereza

            A JLM Meetup!

          4. Donna Brewington White

            Count me in!

          5. JLM

            Actually the pleasure was all mine. Mike is a whip smart double Aggie. A man on a mission.What is a double Aggie, you ask?That is someone who has two degrees from Texas A & M, that other college in Texas.Better still, he is married to an Aggie. That is like winning the Irish Sweepstakes while being Irish. Stronger than an acre of garlic in W Tx.We had a wonderful and enjoyable chat and I was reminded why I want to be 26 again.And where, pray tell, did the original founders of Tx A & M go to school you might ask?Well, that would be THE Virginia Military Institute, my alma mater. Of course, they were still teaching cavalry tactics in those days, no?Behave yourselves, groupies! Everybody is invited to share a bit of coffee next time ya’ll are in Austin. If you give me enough notice, I will even wrangle a BBQ for you. Come one, come all.

          6. ShanaC

            Thank you! (you realize people may take you up on that because of South by Southwest)

          7. Donna Brewington White

            “Come one, come all.”Remember you said this.

          8. Mike

            JLM,Thanks again for taking the time to chat with me, and thanks for the kind words. “Winning the Irish Sweepstakes while being Irish” is a complement, right? I’m an Aggie so I need some help from time to time.Everyone else,Take JLM up on his offer if you can. Luckily for me, his expertise is exactly what I needed for my business but his business savvy would help anyone currently reading this thread.

        3. fredwilson

          he is exactly what i pictured him to be. wonderful person. so happy that i know him.

          1. Mike

            Agreed.Now I just hope that something I said piqued his interest!

    6. JLM

      Good analogy but I suspect one that appeals more to guys than gals. Of course, it is twisted — right on target, mind you but twisted nonetheless — on so many levels.I think you should patch El Tigre in on this subject and do it now. Perhaps he is singularly one of the few fellows who truly regrets marrying a knocked out super model who was apparently faithful, supportive and bore him a couple of great cubs?Apparently her only flaw was she swung that 7-iron w/ the club face a bit too open resulting in a nasty slice and she impinged on Tiger’s “opportunity cost”?

      1. Tereza

        LOLJLM as always your words are as accurate and powerful as Elin’s 7-iron.From experience and observation I’d say that men pick from a population. They’re very focused on what they’re missing. Women tend to hone in on someone’s “something special” and figure out how to make it work.Where women fall flat in dating is that they at times focus too quickly and deeply on someone at the expense of all others, and she loses her leverage.One of my favorite sayings:”Women get married thinking she can change him. Men get married thinking she’s never gonna change.”

    7. honam

      Love that analogy. Vince Lombardi had a great quote on this which I used several years ago on a blog post talking about Fox vs. Hedgehog entrepreneurs:”The essence of commitment is making a decision. The Latin root for decision is to ‘cut away from,’ as in an incision. When you commit to something, you are cutting away all your other possibilities, all your other options.” – The Lombardi Rules, Rule #6 – Be Totally Committed

    8. Eric Leebow

      This is the epitome of it, and that’s why it’s a commitment. If you commit yourself to something, you must give everything else up. Holds true with startups and entrepreneurship. If you commit yourself to starting something as an entrepreneur, that’s what you do, despite all challenges. Marriage can be a parallel to starting and growing a company, as long as you plan to start a family, and raise children.

  4. twasiluk


  5. Venkat

    There’s a very neat toy problem in probability theory that models this. It is usually stated as follows:Suppose you are judging a beauty contest. You get to see each contestant once and have to decide immediately whether or not to judge her (sorry to be sexist here) to be the winner. The moment you pick someone, game over. That person wins.Turns out that if you work the math, the best way to pick is to mentally assign rankings until the first 36% or so are past, keeping track of the top-ranker. Then you pick the first one after 36% who beats the top-ranker. So for instance, if you assign #28 a score of 8.5 and that rank is not beaten between #29 and #36, you pick the first person to score more after that. So maybe you pick #44 at rank 9.5.The point is, you sample the distribution in the first X% and then pick the first outlier after that. The risk is that the ‘stream’ of candidates is badly distributed and you could miss the best candidates right at the beginning. In the worst case, if the candidates come at you in descending order of attractiveness, you will default to the worst one by this method.It’s a nice model of opportunity costs. Applies to job hunts, hard-to-reverse investments and sales. I once almost lost a great candidate for a job because I wanted to sample the opportunity space for too long…Venkat

    1. Mark Essel

      I can’t deny the statistical efficacy of the approach. But we have deep personal histories to guide us. Even our subconscious gut instinct can serve better than memoryless decisions for most human problems.

    2. Rahul Deodhar

      The model is a scientific way. But mostly, in the first stage there are no opportunities. The next stage some filter through. At this point, we end up speculating if it is the product, our estimation of the market need or something else. Even if a good opportunity walks in, it is easy to make a mess of it because of eagerness. This typically happens with project co.s The scope is ill-defined and soon customer expectation rises, scope-creep and the odds with next opportunity change dramatically. Your first customer may or may not give you a recommendation without the creep that takes time and resources blocking the new project.A better model for entrepreneurs mental state is speed-dating rather than beauty contest.

    3. Venkat

      Rahul and Mark. Agreed.. the point of the toy problem is to provoke thought on how to deal with opportunity costs in a data driven way where possible. Of course, if you only have one customer offering you one lousy opportunity, and no more are walking through the door, you probably want to change your strategy so you attract more than one person to your ideas.The problem with opportunity cost is that it mostly becomes evident with 20/20 hindsight via if-onlys. I am interested in proactive things you can do to evaluate a current opportunity against future ones.I guess this is why blackjack and poker are popular games with entrepreneurs.

      1. Tereza


    4. JLM

      Great example but what it suggests to me is the difficulty of applying swift comparative judgment and being confident you have done right by the opportunity.Good judgment — the product of experience.Experience — the product of bad judgment.This implies that at some time you no longer have to rely upon viewing the entire sample but can trust your judgment — your experience — to inform you you have “one of the right ones”.This is particularly true of hiring decisions wherein you may have a number of extraordinary candidates and are not faced with a decision that maximizes but rather optimizes at a very high level.I recently hired three (3) junior officers getting out of the Army and Marines — all w/ good degrees (West Pointers x 2) and MBAs from very good schools. The initial screen was pretty good and they have all proven to be just first rate. Of course, I knew a bit about trade school grads and the military but I am absolutely certain I got the pick of the litter.What I particularly like about your comment, Venkat, is the evidence of intellectual rigor in making decisions. That is an area in which I think we all suffer a bit of deficiency particularly on the beauty contest type decisions.

      1. Venkat

        Agree about the need for, and lack of, intellectual rigor, but with one caveat. We all need more of it, but we often mistake ‘data driven’ or ‘mathematical’ for “rigorous.” With the surfeit of data out there, there’s tons of data drunks out there looking for their lost keys where the data-streetlights shine, rather than wherever they last remember seeing them and retracing their steps.Some of the worst decision-making I have encountered has been backed up by extensive data analytics. mathematical modeling and the like. While some of the best has been fantastically rigorous while appearing to be mainly qualititative common sense….Where math helps is often not in solving the actual problem, but in clearly outlining how to think about it.

        1. JLM

          Fabulous comment!I particularly like:”With the surfeit of data out there, there’s tons of data drunks out there looking for their lost keys where the data-streetlights shine, rather than wherever they last remember seeing them and retracing their steps.”Priceless!

          1. Tereza


    5. fredwilson

      very cool examplei really like it

  6. Kamil Durski

    Nice article

  7. Fernando Gutierrez

    Usually starting a business is irrational per se. Quiting what others consider secure and putting all your eggs in one basket can only be done with a huge faith. And faith is not rational. If you try to model opportunity costs you will end with an excuse to avoid decissions and keep things as they are. I also vote for not thinking too much about them!

    1. Tereza

      Similarly, having children is a totally irrational decision. Based on the facts alone, I don’t think anyone would ever land there.It really comes down to: “Cuz I want to!”The best decision I ever made.

      1. JLM

        I was happily married, established in my career, picking the low hanging fruit, living the life of Reilly and my wife sat me down and said — “we’re going to have a baby” — and my life has never been the same since. Richer, grander, yes. But different.

  8. Mark Essel

    The last few days I’ve been writing about hidden costs, and project management bureaucratic costs. Even simple activities like reading blogs or news, writing posts, or commenting all have opportunity costs for our time.We just make a decision and keep moving, learning as we go.

    1. David Noël

      Mark – would love to see you cross-post to Tumblr. There is a fine small sub-community of entrepreneurs and VCs using Tumblr.http://david-noel.com/post/… Loved (and missed) your great post about tasks

      1. Mark Essel

        That’s odd, I do cross post there :DIt should have shown up on http://messel.tumblr.com/Oh it’s there on the first page, but if you click the post it brings you to my main blog.I can try to set it up so that’s not necessary.*edit*Ok after revisiting my settings, I’m importing my blog posts as RSS feeds with summaries, it’s the best I can do.

        1. David Noël

          Perfect! Didn’t know. Thanks!Added you to the list

  9. Dan Ramsden

    Opportunity cost and option value: ying and yang. Where one goes, the other follows. Just as option value increases with volatility, so does opportunity cost. Just as option value augments equity value, so does opportunity cost diminish it. Flip sides of same coin.The relationship between these and the amount of capital raised – at varying stages of the business cycle – is really complex and really interesting. For example, does more capital reduce or increase opportunity cost for a start-up? I don’t think the answer is obvious.

  10. Senith

    This term is often taught is economics theory! But like Fred, Gretchen Rubin, LIAD, this concept has applications in many areas of life. I teach finance and use it to indicate that this is one of the elements that make up the discount rate used when you are evaluating projects or valuing companies. For projects you are looking for a positive NPV. Why? If the opportunity cost is higher than the current option then your NPV will negative and vice versa. You typically want to pick out positive NPV projects or projects that give you a higher return than the next best alternative or “what you are giving up”.

  11. wslh

    In our small company one of the methods to deal with opportunity costs is rising services prices when we are full, so in some way we can deal to it (hiring new people, doing extra work with more incentives, etc).There are some opportunity costs that you can’t resist strategically, so you need to do something.It happened many times that in the 1Q we have assured the costs for the whole year and something happen in the rest of the year.

  12. phanio

    Opportunity costs are real costs – they are usually measured based on what you know at the time of your decision and thus, I don’t agree with your example as the new project was not known at the time of the decision. You can think of opportunity costs this way. You have $100K and three options for that money. 1) Invest in a new business with potential returns of 15%. 2) Invest in the stock market and see potential returns of 12% or 3) place those funds in a CD with guaranteed returns of 3%. If you take one option over the others – then you give up the potential or guarantee of the other options and that is your opportunity costs. But, these costs are known up front at time of decision – not if something else comes your way down the road – that is an entirely new decision.Plus, what a lot of people don’t understand is that once you commit to an option, all other opportunity costs are sunk – meaning that you cannot go back. Thus, in this example, if you chose option 1 – then the next day pull you money back and take option 3 – it will not be the same as the actual cost of option 3 (or what can be realized) as it is no longer the same (think time value of money).Thus, in your example, once you commit your three engineers – all opportunity costs are sunk. Having a new project come up later and not the resources to tackle it is a whole new decision and does not relate to the original decision or its opportunity costs.

    1. fredwilson

      i suppose that is accurate but i find that way of thinking a bit too rigid for my taste

  13. baba12

    Is a bird in hand worth two in the bush? If one would think of the “What if’s” , they should not be in business…

  14. Tereza

    You have to engage your brain as hard as you can in that moment to define your options. Time box it.Define them clearly. Include an option which is “do nothing and revisit on X date based on updated information”.So if you defer, it’s a choice not a non-decision.Also define risks to each option.Pick one.Make a pledge to yourself: “I made the best decision I could at that moment in time. I will not beat myself up. I will not beat myself up.”Rinse.Repeat.

    1. JLM

      I think one of the essential elements of being an entrepreneur and being a leader in life is the ability to learn from decisions made, to compartmentalize past decisions and to move on.I have made decisions — bad decisions — that literally cost people their lives and the resulting cracks in my soul are irreparable. Some of these decisions were the “right” decisions given the circumstances though the outcome was tragic.Some of these decisions were what I perceived as the best of a set of bad alternatives. Maybe I was right or maybe I was wrong.Some of these decisions, I just plain f*cked up. Not subtle little differences between taupes and khakis and sands. Huge big stupid decisions that had immediate and horrific consequences. But that was the responsibility I had sought and agreed to undertake. And I was generally pretty damn good at it.You have to live with things like this but you never really get over them. But what was not possible was the ability to not make a decision — because that decision is a decision also and might have been more tragic still.In business, I have made a few decisions that have turned out poorly from a financial perspective but the bad thing is almost without exception I would employ the same thought process and arrive at the same decision because you cannot control everything. I bought a hospitality company a month before 9-11. There is no perfume made to cure that decision.

      1. fredwilson

        war is hell but it is an amazing creator of great leaders if they have the capacity to come away mentally intact

        1. Donna Brewington White

          Battle in general seems to be a defining point in leadership. Some of us find our battles in everyday life. It’s what you do with those battles that counts. However, I do not pretend for a moment that there is any comparison in everyday life to the sheer hellishness of war.

  15. Rahul Deodhar

    Do what you have to do.A new opportunity that requires you to break prior commitments and run roughshod over related entities is not an opportunity. We can leave one and pursue other – but compensate those who have committed to you before you found your new calling.Just a mistake I have seen people make.

  16. Nicolas Sauvage

    It is a very interesting post, and very interesting comments.I learned what an opportunity cost was during my time in the UK where I had the best manager I ever had (John), and his definition was *not* the same as yours, yet very profound in how I approach new opportunities.His definition was that an opportunity cost is the cost of trying an opportunity that did not pan out successfully, but that could well have done really well.So using Fred’s example, and assuming the project that needed 3 engineers for 6 months, and assuming it did not work out at the end, the opportunity cost would have been “3 engineers for 6 months” (and nothing to do with other projects we could have done with these resources otherwise).This way of looking at business this way has had a profound impact on how I approach business decisions. It helps remember why we decided to put efforts into something (because it could have done well, with the information we had at the time), and that this cost was needed to create an opportunity. Most managers would have said I wasted time/money/ressources on the projects that did not work out, but this manager always put it back in the context of an opportunity cost that the stakeholders signed-up to.I realize that I use this term a lot, but that it could have meant something very different to the people I was talking about, both in meaning and in positive/negative connotation. I am curious to know if others had the same understanding of this term?

  17. HowieG

    My last corp job this was huge. I was tasked to grow the Western US. We hired an outside Rep company to help. But we had no engineering resources to spare (we custom designed parts for various high science industries like Aerospace) For 9 months I knocked on doors unable to respond to a new request for proposal. I won the development of Ford Motor Company’s Hydrogen Fuel System for their Fuel Cell Cars. A project I had been working 2 years to win. I was told to get 1 month delay. 4 months later we still were unable to move forward. The company decided to take a short term but lucrative project instead of potentially supplying or licensing the technology for millions of cars.I left the firm because of this. The Rep company canceled their contract after 1 year leaving the firm with no one out west selling their product and they were blackballed from automotive. Opportunity Cost.

  18. JinalShah

    What’s beautiful about your friend’s advice is that it also applies to everyday life and not just a start-up environment.

    1. fredwilson

      hi Jinalgretchen writes about everyday life everydayshe’s a great person to follow

  19. taylorwc

    Fred–great point that you can’t let focusing on opportunity cost paralyze you. This topic could be a great segway into maximizing utility, and how that’s unique to every person/company. It can help to think about the immeasurable parts of opportunity cost.

  20. Mike

    If anyone hasn’t seen Dan Gilbert’s TED talk about happiness and our mistaken expectations watch it:http://www.ted.com/talks/da…He presents some pretty striking information about our inability to properly measure opportunity costs, and ends with:”If we’re not here in 10,000 its going to be because… we underestimated the odds of our future pains and overestimated the value of our present pleasures.”

  21. Druce

    To light a candle is to cast a shadow – Ursula LeGuin’Sunk costs’ are related and not always understood. How do you decide whether to drop the first project and focus on the second project?Tally up the costs and benefits of the switch going forward. The amount you’ve previously spent on the first project is beside the point, all that matters is whether the switch will have you in a better place in the future.It’s hard for people to mentally ‘write off’ the previous investment in the first project. You buy expensive servers, a year later your model changes and you need a different set of hardware, it’s hard not view the obsoleted hardware as a ‘cost’ of the switch.

    1. JLM

      The least important pieces of info in business are — what you thought when you started v the reality of today, what you have in it and what you want for it.Every new day is a new investment — buy, sell, hold, abandon ship. Every day.

    2. fredwilson

      you read through the lines druceyou know what ‘”cost” is coming up next week?sunk costs of course

      1. Druce

        I’m surprised when people don’t get that – ie if we move everything to a virtualized environment we have to write off our existing equipment… not relevant, except to the extent you save on taxes from a writeoff… accounting should be an aid to business thinking, not a substitute for it LOL (Buffett)

  22. paramendra

    As in, paralysis through analysis is not entrepreneurship.

  23. PhilipSugar

    I always say “money focuses the mind” Usually the way you can measure opportunity cost is by price….I.e. you are willing to pay me what amounts to $100/hr to solve a problem A and you are willing to pay me $600 to solve problem B.This has always been the biggest challenge for me in providing something free i.e. Twitter for example, and look to profit later.I am not saying the model is wrong…and I think that’s the main point of Fred’s post…..he must deal with this a bunch….and its a big challenge, one I haven’t been able to master.I have given work away for free (for a big fixed price subscription revenue deal)….but it was like having lobster tails at a self serve buffet…..people would pile as many on their plate as they can and not worry about throwing them out.This is in a BtoB environment not a BtoC environment.Again….I totally respect this must be a tough decision for people like Facebook….do something that helps users or do something that drives revenue…..They are very inter-related….more users, more long term revenue….revenue short term….never bad.

  24. Emeri Gent [Em]

    I want to look at this both from the possibility of science and the perspective of art as a pragmatic choice. As economic theory the pragmatic nature of cashflow should and would be top of mind. Cashflow is the lifeblood of any organization and a critical cause of organizational mortality. The opportunity cost of “after-the-fact” is to live in the land of “could have beens” :”I could have been a contender”http://www.youtube.com/watc…If solely looked at opportunity cost and sunk cost as the twin prodigies of economic theory then I am in danger of becoming a Cartesian blockhead, for something has to move in the marketplace whether it is high profile or under the radar. That movement is art, in marketing it is referred to as differentiation but I prefer using the description that blogger Dan Shapiro used i.e. a quirk.Quirkshttp://www.danshapiro.com/b…That does not mean that marketing is art because Sergio Zyman has demonstrated that ad agency’s are often guilty of creating award winning creative instead of doing what they should be doing, which is helping to sell things. What it does mean that thinking of opportunity cost as an “art” brings one closer to realizing the practical value of a work such as “The Art of War” by Sun Tzu, without the political correctness getting in the way of how we look at opportunity.Art of War”http://classics.mit.edu/Tzu…If all I can do is espouse the cost of non-decision then knowing what opportunity cost does not help me. It is what makes decision an opportunity cost which is far more intriguing to me and here I associate where thinking about opportunity cost should take me at a personal level, and that is to understand surprise. Surprise has been studied from a scientific level by George Shackle.The Logic of Surprise” with G.L.S. Shacklehttp://www.jstor.org/pss/25…While I am often found lost and punch drunk when I have been through the cerebral jungle of “economania”, I also understand that fear of confronting the intellectual nature of economics is an opportunity cost in itself, that sometimes painful study has great payback, and that is why G.L.S. Shackle and his work on uncertainty is one of those choices I still have to decide whether to invest depth towards.Ultimately the most memorable moment I have to associate what I think is a pragmatic view of opportunity cost is the account written by Mihaly Csiksentimihayli of Peter Drucker’s rejection of his invitation to be a part of his research on what makes people creative. On Page 14 of “Creativity – Flow the Psychology of Discovery and Invention”, he quotes Drucker’s written response to his invitation:”…I hope you will not think me presumptuous or rude if I say that one of the secrets of productivity … is to have a VERY BIG waste paper basket to take care of ALL invitations such as yours – productivity in my experience consists of NOT doing anything that helps the work of other people but to spend all one’s time on the work the Good Lord has fitted one to do, and to do well.”Drucker isn’t being selfish here but IMHO pragmatic about how he views external invitations as an opportunity cost to his own work. It is interesting that what seems like a sunk cost today, could be the phoenix of something entirely different tomorrow – in the Drucker case, he many years later invited Mihaly Csiksentimihayli to work with him at Claremont University. Not only then does opportunity cost reflect focus and attention but it also creates cause and effect.One of the people who make that cause and effect highly pragmatic and poignant is Hugh McLeod in his book “Ignore Everybody”. Hugh points out his experiences when we wrap the human condition around the conceptions of opportunity cost. It is a quick read but is probably by far the most pragmatic in terms of practical wisdom. I am sure that if Hugh McLeod viewed decisions in his life from a purely scientific view of opportunity cost, the real cost would have been value of not experiencing what he was willing to experience. That his book is for me an artful view of opportunity cost is what makes it useful, and if opportunity cost isn’t useful then it is a wasteful academic exercise.Ignore Everybodyhttp://www.gapingvoid.com/I…I personally also look at the cost of following as a sunk cost, because Hugh McLeod did not follow opportunity, he found opportunity because he wasn’t trying to seek it and that by any definition is a great example of the road less traveled.[Em]

  25. hypermark

    My axiom on these things is “Smart, Strategic, Skin in Game.”In other words, is the opportunity lining us up with a smart customer that is strategic to what we are doing, and do they have skin in the game as to the outcome being successful?Sometimes what is strategic is not winnable. Other times, what is winnable is not strategic; or the skin in the game on the part of the customer is not really there. Sometimes, the big name is not really smart relative to the strategic goals of the business, so they may not help you make your product better, or worse, lead you into one-offs.Knowing which is which is often a good compass.

  26. Dan T

    Focus is a committment to what you are NOT going to do. This is what so many people miss . . blinded by the opportunities. My favorite early stage book about this: Selling the Wheel.

  27. @mdelurgio

    The biggest mistake I have witnessed in the startup world is lack of prioritization of development work. Underlying this is a lack of understanding of opportunity cost. It is so easy to say “Let’s make this feature 25% more ‘perfect'” because it will only take an extra two weeks, and not realize the cost of your team not moving the product forward in other, more important ways in those extra two weeks.Add to this the ongoing qa/maintenance costs plus repeating this pattern over time and you have bloat and a delayed realization of your core vision.

    1. Tereza

      That’s such a great point. Those are decisions that have to be made in the context of both the technology AND the business/the user’s needs.You don’t want to miss an opportunity to identify that something’s “good enough” for now, so you can move down the queue.

    2. JLM

      Most of the guys at the pay window got it 80% right but finished on time.

      1. fredwilson

        i am a big fan of finishing on timei learned that as a kid when i was paid by my next door neighbor to take standardized and IQ tests every saturday afternoon as his “subject” for his masters thesisi found that finishing every question even if i got a few wrong was a lot better than getting everyone right but not finishing

  28. Nick Giglia

    Excellent piece, Fred. Especially in the startup world (or those who are on the periphery, working a day job while trying to put something together), opportunity cost is like a specter always hanging in the background.Unfortunately, it’s a waste of energy and an unnecessary cause of angst. If you make a decision, you need to make peace with it and use it as an asset with which to move forward. Especially in the startup world, that moment of hesitation could cost you your dream, and that’s a terrible pill to swallow.I’ve struggled with this a lot lately, but I think it has to come down to a single-minded devotion to the path you’ve chosen. Luckily, we’re not forced to follow it the rest of our lives, in case something goes wrong, but while you’re committed it needs to be with all your heart.Your dream could be the opportunity cost of worrying too much about the opportunity cost.

    1. Donna Brewington White

      I wonder if just being aware of the concept of opportunity cost in itself helps us make better decisions — so long as we do not let this immobilize us. And, then it seems that pursuing opportunity attracts more opportunity.

  29. ShanaC

    Although not completely logical, one of the more helpful concepts for parts of the decisions I have made over time is realizing that because all opportunities have costs, they all have benefits as well. Decisions flow into each other, and while you are in control of your decisions, it doesn’t mean that you should regret them. You wouldn’t have gotten here without them. Failure in A may have opened you up to success in B.It’s why I believe in seeing as much as you possibly can getting information, seeing your decisions through, yet also feeling bits of your gut process out. There are reasons why you have these decisions to make, you know.

  30. JoeColleen

    “…not being able to do something because you are doing something else…”Well, “doing something else” better be something that creates an opportunity that does not cost, eh!

  31. William Mougayar

    Why is everybody in such a jovial mood for this post. It must be the summer

    1. JLM

      It’s the heat and the malaise. Everybody has become resigned to their own fate. It’s gallows humor.

      1. William Mougayar

        Lol. Hopefully not as bad as this-Mercutio is stabbed in a swordfight by Tybalt, Juliet’s cousin:Romeo: “Courage, man; the hurt cannot be much.”Mercutio: “No, ’tis not so deep as a well, nor so wide as a church-door; but ’tis enough, ’twill serve: ask for me to-morrow, and you shall find me a grave man.”

  32. Michael Diamant

    I see taking command of resource allocation as the corollary to maximizing opportunity costs, and by doing it well, you can stop worrying about those opportunity costs. Maybe it’s another way of thinking about the same thing… but the more positive action oriented way.In fact, IMHO, I think one of the CEO’s top responsibilities is intelligent resource allocation (along with recruiting talent, building culture and being a catalyst for “spocus” (speed + focus)).Always work to maximize opportunities with limited resources (people, money, whatever) to best reach your defined goal. You can then feel confident that few opportunity costs are passing you by.

    1. fredwilson

      I love your list of things CEOs should spend their time on michaelSpocus is a great concept

  33. Donna Brewington White

    Fred — couldn’t believe it — had just commented elsewhere in AVC referring to the concept of Opportunity Cost and came over to yesterday’s post and saw the title!This is one of those concepts that has stuck close all these years — perhaps because the application is so transferable to life in general.I think that one of the most valuable aspects of OC is that it encourages “focus”. We are defined as much by what we DON’T do or choose as by what we DO do and choose.It also encourages staying on track with the vision/mission/purpose of the business (or life) and is a safeguard against acting merely out of expediency or even desperation. Sure, sometimes we’ve got to make some decisions as a matter of survival — especially in this business climate — and we have to be able to live with that. The important thing is that we stay in the place of awareness so that the business decision is recognized for what it is and doesn’t become directional.One of the key values of “opportunity cost” as I see it is all about being empowered to make decisions with “awareness.”

    1. Tereza

      At risk of sounding kooky, professional organizers are replete with stories of people finally throwing out tons of their old junk and suddenly great things start happening.As if making the room available allows for better, on-strategy things to come in the door.

      1. Donna Brewington White

        Somehow I’m not getting all my responses via email — yoohoo Disqus!Not kooky at all…at least not to me. My husband and I occasionally “deaccumulate” in recognition of this principle…but not as often as we should.

  34. Guest

    There’s one form of opportunity cost that more people should pay attention to more often: spending versus investing. An easy way to calculate the opportunity cost of spending over investing is to use a conservative growth rate and then calculate the future cost of present consumption.If a portfolio could average 7% per year over a lifetime, then capital will double every ten years. That being the case, if we assume financial independence is desirable in our 60s, then every decade away from our 60s gives us an opportunity cost of 2x.So someone in there 20s, when thinking of spending, should use a multiple of 16. (From our 20s, four decades of doubling creates a factor of 16.) Likewise, someone in their 30s should use a factor of 8, someone in their 40s, 4; 50s, 2.That being the case, how does that present the opportunity cost of our consumption? How much does the ten-syllable coffee, fancy shoes and shiny car really cost?Here’s a great cartoon to illustrate the point even better:http://www.geekculture.com/joyoftech/joyimages/

  35. Guest

    There’s one form of opportunity cost that more people should pay attention to more often: spending versus investing. An easy way to calculate the cost is to use a conservative growth rate and then calculate the future cost of present consumption.If a portfolio could average 7% per year over a lifetime, then capital will double every ten years. That being the case, if we assume financial independence is desirable in our 60s, then every decade away from our 60s gives us an opportunity cost of 2x.So someone in there 20s, when thinking of spending should use a multiple of 16. (Starting in our 20s, four decades of doubling creates a factor of 16.) Likewise, someone in their 30s should use a factor of 8, someone in their 40s, 4; someone in their 50s, 2.That being the case, how does that present the opportunity cost of your consumption? How much do the ten-syllable coffee, fancy shoes and shiny, new car really cost?Here’s a great cartoon to illustrate the point:http://www.geekculture.com/

  36. Nikhil Nirmel

    I wanted to toss in last minute comment.I think there is one area that opportunity cost is very important, yet widely ignored.That is in the area of choosing who to favor when you as a company have multiple stakeholders, both defined and undefined.I could write an essay on this (I have, I guess), but I’ll just give one example:Let’s say I have the opportunity to reduce the quality of my product (say t-shirts) in a way that increases my overall profit (the amount of fewer t-shirts sold isn’t outweighed by the profit gain of the cost-reduction). Oftentimes, you’ll here people say: you shouldn’t do that, because that isn’t good for the customer.Let’s make a seemingly tangential assumption that we can save lives in the third-world with money. Let’s say vaccinations to cure a disease cost $5 a pop.Let’s also make the assumption that we care more about a person not dying prematurely than we do about a person having a slightly thinner shirt.If you don’t opt for the added profit when you could have saved lives, your decision to ignore a profit-maximizing opportunity is not unlike murder.More broadly, my argument is that whenever we choose not to take an action that increases profit, when we could have used it for a cause that matters more than the gain accrued to whoever gains from our inaction, then we are committing a small moral crime against humanity.Yes, this is a bold claim, but if you think about it, you’ll realize that there’s nothing crazy about this line of reasoning.

  37. Guest

    There’s one form of opportunity cost that more people should pay attention to more often: spending versus investing. An easy way to calculate the cost is to use a conservative growth rate and then calculate the future cost of present consumption.If a portfolio could average 7% per year over a lifetime, then capital will double every ten years. That being the case, if we assume financial independence is desirable in our 60s, then every dollar we spend per decade away from our 60s gives us an opportunity cost of 2x.So someone in there 20s, when thinking of spending should use a multiple of 16. (Starting in our 20s, four decades of doubling creates a factor of 16.) Likewise, someone in their 30s should use a factor of 8, someone in their 40s, 4; 50s, 2.That being the case, how does that present the opportunity cost of our consumption? How much do the ten-syllable coffee, fancy shoes and shiny, new cars really cost?Here’s a great cartoon to illustrate the point:http://www.geekculture.com/

  38. scottsemple

    There’s one form of opportunity cost that more people should pay attention to more often: spending versus investing. An easy way to calculate the cost is to use a conservative growth rate and then calculate the future cost of present consumption.If a portfolio could average 7% per year over a lifetime, then capital will double every ten years. That being the case, if we assume financial independence is desirable in our 60s, then every dollar we spend up to our 60s gives us an opportunity cost of 2x per decade.So someone in there 20s, when thinking of spending versus investing should use a multiple of 16. (Starting in our 20s, four decades of doubling creates a factor of 16.) Likewise, someone in their 30s should use a factor of 8, someone in their 40s, 4; 50s, 2.So a the future cost of a $2 coffee costs a 20-year-old $32 future dollars; a 30-year-old, $16 future dollars; 40yo, $8; 50yo, $4.That being the case, how does that color the opportunity cost of our current consumption? How much do the fancy shoes and shiny, new car really cost us?Here’s a great cartoon to illustrate the point:http://www.geekculture.com/

  39. amnigos

    Ok, I think this is the best and short article that summarizes opportunity costs than anything else I came across in recent times!

  40. fredwilson

    ah, what fertile territory for a blog post”the big deal that wasn’t”i have seen so many of them in my careerand what about the little deal that made the company???

  41. Mark Essel

    We spend so much time and energy trying to make our business real (healthy sustainable/super growth),its easy to attach that reality to existing brands. It’s not just big channel partners.Influential customers, bloggers, angel and VC investors, and yeah getting on Wheaties

  42. awaldstein

    Great comment Charlie.Isn’t extreme attenuation the same as maniacal focus?

  43. Tereza

    Some of the game-changing moments in my career did not feel like it at the time.They were completely obvious at that moment and didn’t feel big at all. The were unexpected yet obvious, win-wins that were practically frictionless.I’d practically be apologizing to people or saying, “Oh, it was no big deal, really…” because they felt small and unheroic. Simply practical.After ruthless searching and qualifying they seemed to ‘fall in my lap’. Hard to explain the feeling.But the first. First is always a big deal….even if it’s a little deal.Ask people something they can easily say yes to, that gives you each something you need without a ton of effort. Something you can learn and grow off of.

  44. PhilipSugar

    That would be a really good post.I promise to comment.Its amazing how many deals that you thought you had to have weren’t important.What I’ve found absolutely true as well is that when somebody says: “give us a huge discount because if you sign us the whole industry follows” is full of it.

  45. Adam Wexler

    can’t think of a better example than twitter snatching up summize. i think that’ll go down as one of the most underrated b2c purchases of this generation…

  46. Rahul Deodhar

    Same here..All my big moments were imperative. They were the only choice and many times I committed to them saying “what the heck -I got nothing to lose”. It was only clear in hindsight that those moments were potent life-forces.

  47. JLM

    My own life has been a series of very small course corrections which have been initiated by others who lent me their eyes or brains for just a second. I saw things I could not otherwise see and I learned things I was dumb to. Thanks, ya’ll!Of course, I did position myself to be at the inflection point and I was smart enough to listen — though I would be the first to admit I also missed some because I was not smart enough to listen.Then I jumped at the chance and shoplifted its life force for my own.Life is ultimately a game of chance and you have to take some chances to awaken the life force within. There are no small chances in life.

  48. Tereza

    placing yourself where you know change is going to happen….always the best place to be. even if you have no clue what direction the cyclone will throw you!

  49. JLM

    As the Great One said — skate to where the puck is going to be.