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opportunity cost

Also called: opportunity costs

The value of the best option you give up by choosing another, such as the contribution of the lessons a tutor could have taught instead.

Opportunity cost is the value of the best alternative given up by choosing another option. It never appears on an invoice or in the P&L, which is exactly why it gets forgotten: the developers, tutors, cash or ad budget an option uses could have produced something else.

It matters most where a resource is scarce. Developers who build one feature don't build another, so the second feature's value is a cost of the first. Fully booked capacity is the same: a lesson sold to a new client in a peak month pushes out a lesson that would have been sold anyway. Cash has an opportunity cost too, which is what the discount rate expresses.

To use it, compare each option with the best real alternative, not with doing nothing, and count the alternative's value in the same terms (contribution or cash, not revenue). When the resource is idle, the opportunity cost is close to zero, so the same choice can be right in July and wrong in May.

Example

Klasna's two developers can spend the next months on one project. Finishing the exam simulator brings 380,000 UAH of contribution for 150,000 more cash: 230,000. Package-renewal reminders bring 260,000.

The opportunity cost of the simulator is the reminders' 260,000, so the simulator leaves 230,000 − 260,000 = −30,000 against the best alternative, even though on its own it looks profitable.

Capacity works the same way. A corporate order of 200 lessons at 520 leaves 100 UAH a lesson. In July, when tutors have free hours, nothing is given up: +20,000. In May each lesson replaces a family lesson worth 184.50, so the opportunity cost is 200 × 184.50 = 36,900 and the order loses 16,900.

Common mistakes

  • Comparing with doing nothing. Compare with the best real alternative for the same people, money or capacity.
  • Valuing the alternative in revenue. Use contribution or cash, the same measure as the option.
  • Assuming spare capacity in a peak. When it is full, every new unit displaces another.
  • Counting several alternatives at once. Only the single best forgone option is the opportunity cost.
  • Forgetting the cost of cash. Money tied up in one project could earn the discount rate elsewhere.

Learn it in the course