I’m a big believer in child labor.
I’ve put each of my children to work at the early of seven.
When they want to earn money, I give them a job.
One of their jobs is to clean my office.
On Saturday, I had to teach my daughter Norah a lesson.
For some reason, Norah thought it was a good idea to stay in the van and play on the idea.
I began to ask her questions about why she was the only one in the van, and her brother and sister were both inside cleaning my office.
I asked her how much money she was earning by sitting in the van playing the iPad.
$0 was her response.
Then I asked her how much money she earned by cleaning my office.
$20 was her response.
At the end of our discussion, she realized she had wasted an opportunity.
The opportunity for her to earn the $20 had vanished into thin air.
Once my office was clean, I didn’t need it cleaned for a few more days.
I then began to share with her the important concept of opportunity cost.
Opportunity cost was one of the first fancy-schmancy business words I learned in college.
I remember having to do a short talk in one of my classes about my favorite business word.
Opportunity cost was my favorite business word back then.
I still love the concept of opportunity cost.
With every choice, we make there is an opportunity cost attached to the choice.
Opportunity cots is defined as the loss of a potential gain from alternative choices when one choice is made.
In the example, I shared above about Norah she had two choices to make last Saturday.
- She could sit in the van and play on the iPad.
- She could come to clean my office.
For choice 1 – playing the iPad, the opportunity cost was $20. By playing the iPad, Norah lost the opportunity to make $20.
For choice 2 – cleaning my office, the opportunity cost was the enjoyment she got from playing the iPad.
For both choices that Norah had, there was something to be lost by choosing one action.
Here’s another example of opportunity cost.
When I was in college, I was a full-time student. One of the opportunity costs of me being a full-time student was I was not able to get a full-time job.
Let’s say I could have earned $20,000 each year as a full-time employee when I a college student.
Let’s assume that the cost of college was $10,000 to attend my college.
The total cost for me to attend one year of college would be $30,000.
$10,000 in college costs + $20,000 in opportunity costs = Total cost of attending college for one year.
Assuming I only took four years to attend college, my total cost of attending college was $120,000.
Many people attend college because on average, earn more money than high school students.
According to a 2015 study by the Economic Policy Institute, college graduates earned 56% more than high school students.
If a high school student works for 40 years and only earns $20,000, then the lifetime earnings would be $800,000 during his/her career.
A college graduate earns 56% more and earns $31,200 per year.
The lifetime earnings of the college graduate will be $1,248,000 over his/her career.
Over his/her career, the college graduate in this example earns $448,000 more than the high school student.
Once you factor in the total cost of attending college, the college student makes $328,000 more than the high school student ($448,000 additional earnings – $120,000 total cost of college)
Opportunity cost is a critical thing to consider when we make business decisions.
By looking at the total costs of the two decisions, it becomes clear which decision is the better choice.
Graduating from college reaps more money than not graduating from college.
Now let’s apply the opportunity cost concept to business.
When growing a business, it is critical to start thinking about opportunity cost.
Every decision we make has an opportunity cost.
Let’s say I have two choices on how I’m going to use my time.
- I have an administrative task that will take 1 hour to complete.
- I have a sales appointment with a prospect.
For choice one, I could pay someone else to do the administrative task. I will have to pay that person $50.
For the sales appointment, I have the opportunity to make a sale worth $1,000.
If I choose to do the administrative task myself, it will cost me $950 to do that task.
I will save $50 by not outsourcing the administrative task.
However, I lose the $1,000 sale.
If I choose to make the sales appointment I close the deal and make $950.
Financially here are the results of the two decisions.
- Choice 1 Do Administrative task = $0
- Choice 2 Sales Call = $950
I think we can both agree that conducting the sales call is the best use of our time.
If I’m logical, it would be a no-brainer decision to conduct the sales call.
Let’s take this a step further.
I could spend an hour working on a marketing project. By completing the marketing project, I’m able to generate six new prospect leads.
I have a 50% conversion ratio, which means for every new lead I get, I make a $1,000 sale.
By spending my time on the marketing project, I’m earning $3,000 for the hour I spend.
Here’s the magic. There is always a better way for me to spend my time.
To increase my earnings, it’s important for me to focus on using my time in a way that will give me the best results.
Thomas Edison said the following:
Many of life’s failures are people who did not realize how close they were to success when they gave up.
I’m going to rephrase his quote by saying the following: