Posts from Small Business

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
forward.

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.

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That Person Won't Scale

One of the best things to happen to startup land this spring is the arrival of Ben Horowitz as a serious blogger. Like his partner Marc Andreessen, Ben has a ton of great experiences to share and he is doing just that right now.

I particularly like his post on evaluating whether an executive "will scale." Ben writes:

evaluating people against the future needs of the company based on a theoretical view of how they will perform is counter-productive

I see this all the time in VC and startup land. An entrepreneur will come into our office and we will be discussing him or her after they leave. Someone will ask "will they scale into a big company CEO?" The answer as Ben points out so well is "who knows?"

Ben also points out that managing a lot of people well is a learned skill:

Managing at scale is a learned skill rather than a natural ability. Nobody comes out of the womb knowing how to manage a thousand people. Everybody learns at some point.

This is why I am a huge fan of getting mentors on the board and CEO coaches into the picture. Good VCs will try to help an entrepreneur "scale" but there is always going to be a tension between the investor and the entrepreneur and it is a good idea to get some other people involved if the entrepreneur wants to "scale" into a leader of hundreds or thousands.

The next time I hear someone says "that person won't scale" I am going to send them to read Ben's post.

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