Recently, I was reviewing a periodical from the Institute of Management Consultants. While I enjoyed scanning all the articles, one about the DuPont Model motivated me to action. In business, this venerated tool is used to analyze investment returns and includes a clear flow chart diagram showing all of the pieces of the financial puzzle in an easy to digest format. I was interested enough to continue more research and reading on this and related concepts. Once satiated, I went on to other tasks.
Soon after this, I was working with a client (let’s call him Sam) when a mutual teaching moment presented itself that ended up in familiar territory. Sam and I were discussing market segments and positioning and he brought up an idea that “everybody is doing this; it should be easy money!” (This is one of those phrases that chills my business blood!) I commented that the only way we would really know is costing it out. I also suggested a mismatch problem existed: this “easy money” move did not match Sam’s business values, target customers, or core company strengths.
This was not the first time this subject had appeared in conversation and it was not the first time I felt I had no good reply to fend off the easy cash flow suggestion. This time though, I paused, thought and waited while scanning the easel paper sheets taped to the wall looking for some way out.
Aha! One of the concepts I had reviewed while searching out the DuPont Model was related! That’s it, give it a whirl: the concept of Opportunity Cost. I asked my client to bear with me; I was neither an accountant, nor economist, but felt this just might explain my resistance to his insistence. I provided the following explanation.
You have $100.00 to spend. You can spend it in one of four ways:
- Put it in the bank
- Invest in your core product (high margin, low volume)
- Invest in your core service (high margin, low volume), or
- Invest in an untested easy money product (low margin, high volume – maybe).
A key factor I interjected here is the condition of limited resources – you do not have $1000.00 to do it all or choose several, you only have $100.00. So when you choose the one you lose the opportunity the other choices might have presented.
I continued with the hypothesis: what if two weeks after we commit to choice 4, the phone rings and it is someone with a once in a lifetime chance to purchase a unique item that never becomes available – something with enormous potential in our core product category? We no longer have the $100.00 to invest – the opportunity cost. My client’s comment – it has already happened before!
Opportunity Cost applies not just to business decisions, but to everyday life decisions as well. When we choose to work late and miss a child’s game. When we choose to sit and watch the game with a bag of chips and a beer and skip that walk. When we choose to remain silent in passing instead of saying I love you to our partner. Business and life include best choices around limited time, money and resources. Always work to maximize your maximum return of all your investments in both business and life.