I was 23 years old when I first heard the term “opportunity cost.”
I had just started working at a creative agency downtown Chicago, and the creative director (who was also one of the founders) had taken me under his wing. We were sitting in the back room, which we called The Library, and at the high-top table we were standing at, he explained the concept to me.
“There are always two costs in a given situation. There’s the cost of doing something, right? You buy a roll of toilet paper, that’s a cost. Say one roll is $2. But then there’s what’s called the ‘opportunity cost,’ which is, what happens if you don’t buy the roll of toilet paper? Sure, you kept the $2, but now you’re shit out of luck.”
Immediately, the concept made sense to me — and I was fascinated.
For four years working at this creative agency, I saw this concept play out dozens of times per day — and every time a teaching moment would present itself, my mentor would turn to me and say, “What’s the opportunity cost here, Cole?”
- A client wouldn’t pay their final invoice. The cost was $5,000. But the opportunity cost was spending dozens of internal hours and company resources in order to chase after the $5,000.
- A bad hire would start to really show their lack of expertise. The cost of firing them was eating the $15,000 already spent investing in them. But the opportunity cost was how much money the company would continue losing because the hire couldn’t execute the work they were being paid to do.
- A vendor would increase their prices, which cut our margins. The cost was a few extra thousand dollars we had to spend to keep working with them, but the opportunity cost of not using them would most likely cost us a big client.
Learning what “opportunity cost” was, and all the different ways it could play out in a business setting, became a crucial part of my job.
However, I gravitated to the concept because I realized I had always had an awareness of what “opportunity cost” in a situation was — I’d just never had a name for it.
- A friend would ask if I wanted to go out after work to meet a few other friends at a bar. The cost was that I’d have to give up my workout for the evening, and probably $30 spent in drinks. But the opportunity cost was me missing an opportunity to meet new people.
- My mentor would invite me to an event — like a rooftop fashion show/fundraiser on a hotel rooftop. The cost was that I’d have to give up my Saturday afternoon/evening spent writing. But the opportunity cost was me forgoing a chance to be surrounded by very successful people, talk to them, learn from them, and even expand my network.
- A freelance client would say, “Hey, can we edit this article a bit?” even though they hadn’t been a client for months. The cost would be me doing an hour or two of work for free. But the opportunity cost (if I said, “I have to charge you for this,” or ignored them altogether) would mean they probably wouldn’t keep referring me business.
And over time, I started to develop a method as to how I wanted to make decisions for myself — not just in business, but in relationships, with finances, with the friends I wanted to keep, and in my life as a whole.
In every situation, I ask myself which side of the coin has more to gain?
Let me use the first example I mentioned above as a case-in-point. If you have a client that suddenly goes radio silent and doesn’t pay their last invoice, that “cost” to you might be $5,000. It’s tangible. It’s a very clear amount of money. And you know that by not pursuing them for that money, you’re “losing” $5,000.
This is where most people stop.
They see this first side of the coin and they think to themselves, “I’m losing $5,000. That’s bad.”
What most people don’t take into account is everything they’ll need to do (all the other losses they’ll need to incur) in order to pursue the $5,000: court fees, hours of your own time and energy, reputation cost, the list goes on and on. Which means, at the end of all your efforts, you might very well spend upwards of $10,000 in order to get the $5,000 that is “rightfully yours.”
Did you win?
In one way, sure. But you also lost too. Which means you’re ironically in the exact same place you were when you started (where you had something to gain and something to lose), except now, you’ve lost more than $5,000.
You’ve lost $10,000.
In stock trading this is referred to as “selling a losing position.”
Traders live and die by the concept of opportunity cost.
If you buy a stock at $100 and it drops to $75, what do you do? Do you hold it and hope it goes back up? Or do you sell, move the $75 you have left into another stock, and make more than you lost?
There are a lot of people in the world who struggle to get past that first move on the chess board — selling their losing position. They have a hard time making that decision without feeling like they’ve “lost.” What they fail to see, however, is the continued loss they’ll incur if they choose not to sell.
Which is why both sides of the coin have to be weighed against each other.
So, how should you be thinking about Opportunity Cost in your everyday life?
The truth is, I take opportunity cost into just about every single decision I make in a given day.
- If I eat this magnificent piece of gluten-free, dairy-free, soy-free cacao leftover birthday cake for breakfast, my “cost” is that I won’t be starting my day with a healthy meal, and I’ll most likely have a stomach ache by 10:00 a.m. But my opportunity cost here is — if the cake will go bad by tomorrow, when else will I get to have a piece of cake for breakfast?
- If we take on too many clients at my company, Digital Press, the “cost” is that I’ll have to intensely manage that growth, which will most likely mean more coffee and more stress, and less sleep. However, the opportunity cost would be missed revenue, slower growth, etc. Another opportunity cost would also be what else I could do with my time if it wasn’t being spent managing growth — like, say, working on a new product or service offering that could potentially accelerate our growth even more, but require less hands-on management?
- If I stay up late writing on a Monday night, the “cost” is that I’ll be tired the next morning. But if I don’t stay up late writing, then the opportunity cost is what I could have written or gotten done (instead of going to bed early).
This is how I think about every decision I make in my life. And I have found, without fail, that the best decisions end up being the ones that push beyond the first, most obvious “cost” and are instead based on opportunity cost — the clearest one being the relationship I had with my mentor.
For the four years I spent working with him, I had multiple people (friends, family members, etc.) offer me jobs at other companies. Jobs that paid higher salaries. Were in nicer offices, Came with flashy perks like a full bar and free coffee lounge on the first floor. But the reason why I turned all of them down, and continued working closely with my mentor, was because I saw the opportunity cost.
If I stayed at his agency, my “cost” was pretty obvious.
I was making $20,000 — $30,000 less per year, than if I had taken a job elsewhere. But if I left, the opportunity cost was the fact that I had direct access to someone I very much looked up to, and wanted to be like. A new job might pay me more money, but I wasn’t going to get to work directly with the founder of the company. A new job might come with free lattés, but it wasn’t going to give me a mentor. And so what drove my decision to stay (for nearly 4 years) was the fact that I was able to see the long-term benefit of forgoing a short-term pay raise.
When I did finally decide to “take the leap” and leave his agency, sure enough, it was “opportunity cost” that drove my decision. The “cost” of me staying had become greater than the “opportunity cost” of me leaving — and seeing what else I could learn on my own. It was the moment I had been working toward for years. But when it finally came, I wasn’t just “leaping” with a gut feeling. I was taking an educated, informed step based on the theory of opportunity cost.
And I went on to start my own company shortly after.
This article originally appeared on Medium.