What is opportunity cost and how can you minimise it

The growth of your business depends on the choices you make. Every business owner has to make tough decisions on daily basis and give up the benefits of a certain option to choose a more beneficial alternative. The loss of benefits of the next best alternative is what constitutes opportunity cost.

Every business comes across these trade-offs in their day-to-day operations. A business owner needs to keep the opportunity costs in mind while choosing alternatives that work best for the business. 

It may sound like you are missing big benefits and making a bad choice that can hurt a business. In reality, the opportunity cost is evaluating which is the best choice in a given situation and why.

In this article, we will look at the different ways in which a business owner can minimise the opportunity cost in a business and ensure sustained growth. 

What is an opportunity cost?

Opportunity cost is the value of the next-best alternative use of a given resource. In the case of a business, we usually consider the opportunity costs of tangible resources such as money and assets and intangible resources such as time and employee satisfaction.

For instance, when you decide to increase your production you may lose out on employee satisfaction. This will affect their productivity and may lead you to incur losses. There are tough decisions that every business owner has to take knowing that it will result in the loss of an alternative business resource. You have to keep in mind that being a business owner, the resources at your disposal are limited and you have to invest in those that can help you achieve your business goals.

Here are a few examples to help you better understand the effects of opportunity cost on business. 

Example 1 – Purchasing Inventory vs Hiring More Employees

There may arise a situation in your business where you have to make a decision between buying new inventory and hiring new employees to tackle a rise in demand. While the rising demand will require you to purchase more inventory, hiring new employees is a long-term gain as it can boost the production capabilities of a business.

However, let us say there is a sudden influx of a new trend in the market. If you want to cash in on this trend, it is ideal to stock the required items quickly to earn as much revenue as possible until this trend lasts. On the other hand, if you decide to hire new employees to increase your productivity, you may not be able to meet your requirements due to urgency and a lack of time. Training new employees and helping them align with the business objective will take time and in the meanwhile, the trend may die down. The opportunity cost of hiring new employees in this situation is high and not a decision business owners would take. 

Example 2 – Updating Technology vs Using Existing Technology

As technology advances, businesses need to keep themselves updated with the latest iterations to thrive in a competitive market. You might lose out on business opportunities if you continue to use old equipment.

For instance, in the current scenario of a growing digital economy, you may lose customers if you do not offer the option to pay online. The opportunity cost of still using cash as the only method of payment can hinder your business growth and limit sales. 

Example 3 – Maintaining Liquidity vs Making Long-term Investments

Liquidity defines how quickly a business can turn its assets into cash. Being liquid in a market allows businesses to adapt to new business opportunities quickly without trading-off its asset value. If you are in a seasonal business, maintaining liquidity can be helpful to increase the purchase of inventory when the peak season approaches.

However, investing in long-term assets like a factory unit or land can offer expansion opportunities for businesses at a later point of time. But in the case of a seasonal business, using your cash for a long-term investment has a very high opportunity cost associated with it. In the case of a deadlock, you can avail a small business loan to cover such investments.

How can you measure the opportunity cost?

The opportunity cost of a commodity is calculated in terms of the alternative commodity sacrificed and is not assigned a monetary value. For instance, if you have the option of purchasing a laptop priced at Rs 20,000 to meet your urgent needs and a high-end desktop priced at Rs 2,00,000 that will also be beneficial in the future, the opportunity cost of the desktop will be 10 laptops and the opportunity cost for the laptop will be 1/10 desktop.

How can you cover opportunity cost?

Do a cost-benefit analysis

It is necessary that you perform a cost-benefit analysis before you take any major business decisions. In the example mentioned above, while you can fulfil your immediate needs for a lower cost, you must also consider the future utility of an asset.

While the desktop is much more expensive, it may prove to be more useful in the future and help you boost business in a better way as compared to the low-cost laptop.

Share your resources

Sharing your resources for a number of business operations can help cut down the opportunity cost and help in business growth. For instance, if you run a retail business, it might be a good idea to invest in larger premises that will enable you to have a larger store and also create space for increased storage thus, helping you to expand your operations.

Invest Your Finances Wisely

Investing your money wisely is the best option to save opportunity costs and promote business growth. For instance, if you own a graphic design studio and opt to purchase a desktop that lets you accomplish more tasks and work on heavier files, it is worth the opportunity cost of a cheaper laptop. Additionally, buying a higher-end model will allow you the freedom to use new software as it launches, without being limited by the hardware. 

Factor in Time

Time is money and it is imperative that you consider the time that every opportunity takes up. It is one of your most important resources and should be a part of your decision-making process. If you are in the business of fast fashion or other similar industries that require you to follow trends and move merchandise quickly, it might be a better option to outsource the production of a new product that may have a short-lived market. The time it takes to change your manufacturing schedule and for your employees to get accustomed to producing new products might be better spent on marketing and sales.

Since every decision involves sacrificing at least one alternative, opportunity cost is unavoidable for any business. The best way to ensure the growth of your business is to carefully consider all opportunity costs and work towards minimising it with every decision you take.