How To Make Better Decisions By Understanding Opportunity Cost
I hate hacks.
“Life hacks,” “career hacks,” “date hacks,” “productivity hacks,” or “fitness hacks.”
Hacking something together makes sense in the right context—working at a hackathon or finding a solution to a difficult problem when you’re under pressure. But when it comes to building out your life in a way that allows you to succeed at work, you don’t want to rely on hacks. If you’re trying to find a solution to a serious problem that comes up repeatedly in your life, why would you defer to something haphazardly thrown together and designed to be a quick fix? This would be like duct taping your malfunctioning muffler to your car instead of researching the best mechanic who can fix your muffler at the right price. The reality of hacks is that they compete for our attention (if you’ve ever been overwhelmed by “life hack” articles, then you know what I am talking about), run against our way of thinking by their nature, and are rarely built to be a sustainable solution.
(I also can’t get over the fact that “hack” means both a quick, unique, and often haphazard way of achieving an outcome and a poorly trained practitioner.)
Decision-making takes time and energy. Succeeding at jobs with higher earning potential and flexibility requires you to have developed your decision-making ability. Without a habit of systems and frameworks upon which you can rely, you’ll find yourself exhausted and stressed out after a long day of decision making. If you’ve ever gone to the grocery store after a long day at work or studying and find yourself overwhelmed by the options available to you, you’ve experienced decision fatigue at what economists call the paradox of choice (more choices make it harder to make a decision).
When trying to compare courses of action or opportunities, use frameworks to understand how to proceed.
Eventually, you’ll slip and start making worse decisions and put your job and work at risk.
Instead, you should defer to frameworks to help you make decisions. When trying to compare courses of action or opportunities, use frameworks to understand how to proceed.
When I talk to young people trying to decide what to major in, I encourage them to study economics for this reason. While psychology is billed as the science of thinking and decision-making, economics (especially microeconomics) is the science of human action. Why did consumers purchase product A and not product B? How would behavior change if the price went up? What if the price went down? How would the price change (and why) if the quantity supplied decreased or increased? The insights from questions like these can be applied to our own lives and to the lives of other people with whom we work.
The first framework I teach to people I work with is opportunity cost. Translated from academic economics jargon, the opportunity cost of any given action is the value that taking the next-best option would bring. This is one of my favorite frameworks for making decisions.
You can use opportunity cost as a way to compare options for yourself, to understand the stakes at play for others in negotiations, and to present new options to potential customers. It’s even a tool you can use to understand why friends might make the decisions they do or why a date decided not to go on a second date with you.
Opportunity cost is the fundamental way in which people compare between alternatives. This doesn’t assume perfect knowledge or rationality, either. People make decisions by comparing the perceived cost of option A to that of option B. Those perceptions may be objectively incorrect (people are often bad at understanding the opportunity cost of going to school, for example), but clarifying and informing those perceptions is what conversations and marking are for.
Opportunity cost is the fundamental way in which people compare between alternatives.
Take the simple example of trying to decide whether to go out with friends and drink or to stay in and read for the evening.
The cost of staying in is that you don’t get to see your friends tonight and you may not meet some new people.
The cost of going out is that you may get to bed later, whatever else you could have spent the $20 for drinks on, and getting whatever enjoyment you could have had from reading the book tonight.
Assuming your friends don’t leave town tomorrow and your book doesn’t magically disappear, the cost really is the time going out and whatever else you could have spent the $20 on.
This is a pretty benign example but it makes clear that every decision you make comes with a cost. Most simply, opportunity cost is the value of your time.
You can use opportunity cost to weigh heavier decisions than whether or not to go out.
Example: Should You Quit Your Job?
John wants to quit his job sometime soon but doesn’t know when. He tells himself he’ll quit when he stops getting enough value from the job to justify staying around longer but he doesn’t define what that looks like. He’s concerned his coworkers will stop talking to him, he’ll lose his professional network, and he doesn’t know if his freelancing business he currently runs will make enough money to make up the difference from his salary.
When should John quit his job?
If John thinks in terms of opportunity cost, he can get an idea for when staying at his job becomes more costly than quitting.
Some of the costs of quitting include:
- Losing coworkers as friends.
- Losing his professional network.
- Losing his salary.
- Losing whatever opportunities to learn remain at the company.
- Losing status or prestige.
He can ask himself, “all else held equal, what opportunities am I missing out on by staying in this job? What knowledge am I not learning? What people am I not meeting? What clients do I not have the time to take on?” This reframes the question from the costs of quitting to the costs of not quitting.
Some of the costs of not quitting include:
- Not bringing on new clients.
- Not learning new information for a new role.
- Not growing a diversified network.
- Not taking on new leadership responsibilities.
- Not earning more in a role that has uncapped earning potential.
John should quit when the cost of staying at his job is greater than the cost of leaving.
Instead of just saying this to himself, he can make clear the costs of staying and the costs of leaving and then work to reduce the costs of leaving and increase the costs of staying. He might make new friends outside of his coworkers, reducing the social costs of quitting. He might bring on new clients for his side-business, reducing the cost of losing his salary—especially when compared to the extra time he’ll have to work with new clients. He might get himself invited to events full of interesting people, reducing the cost of losing his professional network from his job.
Understanding opportunity cost makes it easier for John to figure out when he’s not getting enough value out of his job to justify staying around. He doesn’t have to stress about the decision to leave his job because he can reframe it into terms of opportunity cost.
Example: Should You Go (Back) to School?
Stacy is a 20-year-old who took a leave of absence from her prestigious college to go work at an early stage startup. She’s come to the end of her year off and doesn’t know if she should go back to school or keep working at the startup. On the one hand, she enjoys, is good at, and doesn’t have to pay for school (scholarships are a thing, people). On the other hand, the last year at the startup allowed her to really flourish in her competencies, paid relatively well, and gave her the opportunity to grow her professional network beyond that of any of her peers.
When you’re trying to decide how to advance a negotiation, sit down and ask yourself, “what are some of their perceived costs of working with me?”
Most people would tell Stacy to just go back to school, get her degree, and then go into the work world. They give her platitudes about how she needs to be a well-rounded person or how you can’t put a price on education. Even worse, they tell her she will have her whole career to work but only now to get an education.
This is not a helpful way of framing the conversation.
If Stacy thinks in terms of opportunity cost, she gets a clearer picture of whether or not she should go back to school.
Some of the costs of staying at her job include:
- Getting her degree on schedule.
- Whatever she might learn in school.
- Socializing with peers.
She can ask herself the same question John asked, “all else held equal, what would I miss out on by going back to school? Who would I not meet? What experience might I get that I would otherwise not be able to get? Where would I be in two years’ time if I stayed at the job versus going back to school and getting my degree?”
This makes it easier for her to compare some of the costs of going back to school:
- Not growing her professional network.
- Not building a work portfolio at 20 that most recent grads don’t have until they’re 30.
- Not getting a 2+ year head start on her peers.
- Not socializing with people at work.
- Not learning whatever professional skills she learns at work (which her peers from school will have to learn upon graduating, anyway).
Notice that not getting a degree is not actually one of the costs of staying at her startup. She can always go back to get the degree. There’s no obscure law that says you have to finish your degree before turning 25.
(My friend Ed Latimore is a good example of somebody who waited until he was 30+ to get his degree and is glad he did so.)
Example: How Can You Advance a Sales Negotiation?
I have a couple clients working to go from being freelancers to owning full-fledged consulting businesses. We spend a lot of time on sales, business development, and negotiating deals. It’s not uncommon to get to the point in a negotiation where it looks like a big deal will close and the other side comes back to say they want to wait a few weeks before starting on the project.
This kind of kicking-the-can comes from the other side perceiving the opportunity cost of doing business with you now as being greater than the cost of proceeding with their other priorities. If you can reduce the opportunity cost of working with you, then you can get progress on the negotiation. If you can’t, then you have to wait.
When you’re trying to decide how to advance a negotiation, sit down and ask yourself, “what are some of their perceived costs of working with me?” The more you know about their other priorities and their KPIs, the better the picture you can paint here.
(This is one reason I am a fan of conversation-based sales and business development systems like the SPIN system.)
Use opportunity cost to get your foot in the door with new opportunities and valuable people.
Some of the hidden costs of working with consultants and freelancers include the time and energy it takes to work with them in the first place. As a consultant, you are an outsider to the team. They have their own habits, norms, and ways of working together that exist separate from you. When you come in, you impose an undefined cost to them of trying to work you into their existing habits. You can lower this cost by working into your negotiation a period in which you work with the team and learn their habits and norms so as to minimize the cost of working with you.
You can also raise the relative cost of their next best option by imposing scarcity on working with you. One of my clients works with a team of subcontractors. Their time is valuable and they all fight off additional opportunities constantly. By signaling to his prospect that the best subcontractors might not be available in the future, my client raises his prospect’s cost of not working with him.
Example: Should You Outsource Low-Value Work?
One of the clearest applications of using opportunity cost as a framework for making your life better is outsourcing low-value work. As you gain more experience and skill, the menu of options available for you at any given moment grows. You can schedule a flight or do outbound cold emailing or work on a client project or set up an interview or write a book or build a new program or talk to investors or any number of other activities.
Just because you can do any of these activities doesn’t mean you should do any of these activities.
It takes an hour to schedule your flights and accommodations for an upcoming conference. What could you accomplish in that hour? Can somebody else who has lower opportunity cost do that scheduling for you? The opportunity cost of scheduling those flights and accommodations is you don’t get an important proposal completed for a client.
Even as a student, you have to work on an upcoming term paper but you also have to work your way through scheduling a ton of meetings for the club you run on campus. Which can you do that somebody else cannot do? The opportunity cost of scheduling those meetings yourself is that your term paper doesn’t get written.
The solution here is to outsource or automate your work.
In The 7 Habits of Highly Effective People, Stephen Covey presents a 2×2 matrix for trying to make sense of urgent and important work. Highly effective people, he says, get the urgent+important and the not urgent+important done themselves. The urgent+not important are those tasks that have a high opportunity cost but need to get done—like scheduling your flights and accommodations.
When trying to figure out what to do versus what to outsource, think in terms of opportunity cost. Ask yourself, “are there higher-value activities I have to accomplish that I could accomplish in the time I spend working on this activity?” If the answer is yes, outsource that activity.
Example: Should You Extend Your Lease or Move Somewhere Cheaper?
For an example not related to work, here’s a situation I’ve dealt with recently.
My lease ends in a few months and I can either extend it at a slightly higher rate or I can move out into a cheaper apartment elsewhere. I don’t care much for size as much as I do for location. I can probably find a similar apartment elsewhere in the city at a good rate and in a good location. Finding an apartment takes time and I am bleeding into the territory of Very Busy Person. I place a premium on my time. While the cost of staying might be greater than the cost of leaving, the opportunity cost of leaving the apartment is higher than the cost of staying. The time and energy it takes to find a comparable apartment is so great that I will happily spend extra money to stay where I am.
Using Opportunity Cost to Gain Yourself Opportunities
Use opportunity cost to get your foot in the door with new opportunities and valuable people.
There will always be people whose time at a given task is more valuable than your own. When you’re in the early stages of your career, or starting a new career track, these people are the accelerators through which you can get ahead. You can be hired by them, work with them, gain social capital and a positive reputation from them, and use what they know as a springboard for opening up new doors and opportunities that others just wish for.
For whatever it is you want to learn or become better at, find a Very Busy Person who is skilled and whose time is valuable. If you want to become a professional artist, this could be somebody who already makes a living selling their art. If you want to become an accomplished freelance software developer, this can be somebody who has built their career for years around doing that. If you want to become a fitness trainer, this can be somebody who has a reputation for being an in-demand professional fitness trainer.
Before approaching that person, get an idea of what they might need to spend their time on. Figure out what their highest opportunity cost activities are that you have the ability to accomplish. These might not be tasks directly connected to their field of mastery. The fitness trainer may need help doing the books for her business. The artist may need help booking speaking engagements. The software developer may need help generating new leads. These are activities that fall into the “Outsource or Automate” quadrant above. If you understand your own opportunity cost well, then scheduling speaking engagements for a professional artist, while working closely with the artist and learning from them, might be the best use of your time. If it isn’t, then you should find a Very Busy Person more advanced in their career.
Make yourself useful to them. Leverage the relatively low value of your time to meet the activities that are low-value for them.
Zak is a communicator focusing on issues of education, innovation, and social change. He’s the author of the 2016 Amazon best-seller, The End of School: Reclaiming Education from the Classroom and is currently finalizing The Little Guide to Learning Anything. He regularly speaks on issues of learning, social change, innovation, and the changing jobs landscape. He is a founding team member at Praxis.
This article was originally published on FEE.org. Read the original article.