Not understanding “opportunity cost” could be costing you bundles of money.
We have ancient sayings around the concept of opportunity. We say, “opportunity knocks.” And, we get excited by an “opportunity of a lifetime.”
In addition, of course, “when one door closes another one opens” is a favorite way of offsetting a disappointing loss and creating hope for an opportunity in the future.
You have likely lost many opportunities. Maybe you didn’t see the email in time to get in on a sale or didn’t sign up in time for an event that sold out. However, that’s not opportunity cost. Opportunity cost is quite different.
Opportunity Cost Defined
Opportunity Cost is a benefit that one might receive but chooses to give up to pursue another course of action.
In other words, if you decide to pursue a project and it results in less income versus another plan or project, that is an “opportunity cost”. Said another way, if your decision ends up costing you an opportunity to do something that might have made you more money, that represents lost income opportunity. Your decision has effectively “cost” you opportunities to make more money during that same time period. Moreover, once it is lost, you cannot regain that value or make up for the lost benefits.
That’s the opportunity cost issue. Sales, research and development, production, expansion, and marketing all have costs and must be measured against the short-term and long-term benefits and profit potentials. It’s the only way to really know if you are making a proper investment in your time and/or money.
There are so many conundrums facing small business owners every day! For example: should you buy new equipment, to increase your production or spend that money on Facebook ads? This assumes you don’t have money in your budget to do both, of course. Money is often more finite than time!
When choosing to invest money in project A instead of B it comes down to the infamous cost/benefit analysis that we often just try to ignore. Especially if we are not sure how to do the full measurements of the costs/benefits to start with.
There is a formula that can help with the decision, but it’s not fool-proof:
Opportunity Cost = Return of Most Lucrative Option – Return of Chosen Option
Opportunity cost is typically defined in terms of money, but it may also be considered in terms of time, person-hours, mechanical output, or any other finite resource. But in all cases, it means you are measuring your results and comparing the two options.
Here’s the Tricky Part
Perhaps you have chosen to do a commission that will take twice as long to do compared to your normal creative endeavors. Said another way, you could create two pieces in the time it will take to do the one on a commission.
To make it more confusing, let’s say that you can only charge a 50% higher price premium for commissions. In simple math, let’s imagine each normal item sells for $100, so creating two would potentially bring you $200 gross income. The commission item – created in the same amount of time – will bring you $150. It would appear that your time is better spent avoiding commissions. But of course, it’s never that obvious, is it?
The monkey-in-the-wrench is the guaranteed ROI, or Return on Investment. This is a complex assessment because the commission is a “sure thing”. When complete, you get paid. Meanwhile, the sales of the two pieces you would have created instead of the commission might take months to sell. This is especially true if you are not selling wholesale to retail stores and/or consigning to shops or galleries. If you are selling one-to-one online or at retail art shows, every piece you make has a risk of taking months to find a home. Or perhaps never finding a home. (We won’t even go into the “cost” to your confidence when something you have created never gets appreciated and adopted!)
I think the above example shows that it’s not always cut and dried as to which of the two options will be worth more to your business. However, the more you pay attention to the actual costs, the more you can begin to make better decisions.
If you were to spend your time doing A and B was a more guaranteed income or more lucrative, why do A? For example, what if you can hire someone to come and watch your kids for a couple of hours after school while you make profits that will cover that expense and MORE. This would seem to be an obvious choice.
Bottom line is: time is not replaceable and time is money.
For example, have you ever really looked at all the time it takes to do a week-end art show? It might be more useful to do things like researching stores and galleries that would be a good fit for your art. Or maybe you should create mailing pieces that you can send to retailers to introduce your line. Of course it’s always “time well spent” when following-up on inquiries to create new accounts or get reorders from current wholesale buyers.
You could do any of the above and likely have a better long-term profit versus doing that retail art fair that has a monster booth fee, takes days to prepare for and days to recover from, AND has a high risk of bad weather every year.
Heck, if you have been a good little marketing machine, you will have a list of retail buyers from past shows and can email them and let them know that you are not doing the “Finger’s Crossed for Good Weather Art Fair” this year and from the money you are saving, you are having a big “subscribers only” sale on your website.
Opportunity needs your respect. Don’t squander your precious time doing things that are unproductive or don’t add value to your business. It’s fine to indulge in “non-productive” activities from time to time, but sitting in front of Facebook watching cat videos is clearly not using FB as a tool for growing your sales. Don’t fool yourself into thinking that you are helping your business by doing things that you know will never add to your success or profits.
You can never get time back, nor can it be banked for future use. Mis-use of your time, along with money, is an opportunity cost that will keep you from being successful and thriving in your art business.