Opportunity Cost

The problem it solves

The price of a decision is usually discussed as money and hours, because those are the parts that leave a record. A budget line has a number, a team has a capacity, and both of them can be put in front of a group and argued about.

What the same money and the same weeks would have produced somewhere else leaves no record at all. The project that wasn't started has no invoice, no burn-down and nobody reporting on it, and the whole of the cost that decides whether a choice was any good sits in that second, unwritten column.

So decisions get taken against the wrong comparison. The question in the room is usually whether a thing is worth doing, which compares it against doing nothing, and that was rarely one of the available options.

The idea

The cost of a choice is what the best rejected alternative would have delivered. Not the money, which is an input, and not the sum of everything rejected, which would make any decision taken in a rich field look ruinous.

Enlarge: One rejected option carries the whole cost, and it's the tallest one.

Four vertical bars. The leftmost is solid and labelled what you chose. To the right of a divider stand three outlined bars of decreasing height, labelled together as what you gave up. A bracket above the tallest of the three marks it as the cost of the choice, and a line beneath reads that the cost is the tallest thing you gave up rather than all of them added together.

One rejected option carries the whole cost, and it's the tallest one.Close

One rejected option carries the whole cost, and it's the tallest one.

That the cost is the single best alternative rather than the pile of them is the part people get wrong most often, in both directions. Summing inflates, and it usually shows up when somebody wants to argue against a decision that has already been taken. Averaging deflates, and it usually shows up when somebody lists several weak options alongside a strong one, which makes the chosen path look better the more bad ideas are on the table.

The economics is two centuries older than its use in management and the transfer holds up well, with one difference worth naming. An economist works with prices, which are public and comparable, and a team choosing between an integration and an onboarding rebuild has two estimates of different things made by different people. The comparison is still the right comparison, and it's a judgement rather than a calculation, so a decision recorded as though it were arithmetic is claiming a precision it hasn't got.

How to use it

Name the alternative before deciding, in one sentence, in whatever document the decision lives in. Doing this costs about a minute and it's the whole technique, because people reliably don't generate the comparison unprompted and reliably do respond to it once it's written down.

Compare like for like. If the choice is eight weeks of a team, the alternative is the best other eight weeks of that same team, rather than a wish from a different budget or a different year.

Then say the no out loud to whoever it lands on. A trade-off the affected team hears is a decision they can argue with, and one they don't hear arrives months later looking like neglect. They also hold information about what the rejected thing was worth, which is exactly the number the comparison was missing.

For anything already underway, ask the forward version. Offered this half-finished project and the six months it still needs, would you start it today over everything else those six months could buy? The money already spent is gone either way, and it belongs in neither column.

Where it breaks down

Every concept here has one. It is the section most summaries leave out.

The alternative is a guess, and the whole comparison inherits that. Both sides of the sentence are estimates of things that haven't happened, and the rejected one is worse estimated because nobody has scoped it. Buchanan's argument goes further and says the cost exists only in the mind of the person choosing, at the moment they choose, which means it can't be audited afterwards and shouldn't appear in a business case as though it could.

It's a fine instrument for arguing against anything. Because the cost of any decision is whatever the objector nominates as the best alternative, an unfalsifiable objection is always available. The defence is to insist the alternative be specific, resourced and something the objector would actually sign up to run.

Comparing everything is unaffordable. The method assumes a set of options already on the table, and generating that set is the expensive part. For most decisions the correct depth is one named alternative rather than a survey, and a team that runs a full comparison on each choice has spent the resource it was trying to allocate.

The visible option keeps winning anyway. Knowing about the invisible column doesn't make it visible, and the option with a sponsor, a revenue figure and a slide keeps beating the one with an estimate, even in rooms where everyone can define this term. Naming the alternative helps and it doesn't level the field.

In one line

Ask what the best thing you're giving up is, name it out loud, and tell the people it belonged to.