We all know that when we purchase a specific product we are leaving out a considerable number of goods, each one capable of offering us benefits that we will not necessarily find in the item we choose; Well, in finance, this situation is known as opportunity cost. But, strategically, there is something much deeper within what is the opportunity cost, beyond just making an estimate of those advantages that we give up in favor of our purchase choice.
Within the corporate world it is always necessary to make quick decisions at the right times in order to guarantee the operability of the company, having this reality, it is possible to get an idea of what the opportunity cost is and what its real weight within a company. Although it seems somewhat difficult to associate, the development of an opportunity cost is crucial in everything related to the construction of corporate objectives and the development of a system that allows each of them to be met systematically and efficiently.
What is opportunity cost?
In order to have a more accurate perception of what the opportunity cost of a company is and the entire theory that revolves around the opportunity cost as a theory of the world of finance, it is necessary to always be aware that every institution has a limited number of resources to availability to be able to cover the operating expenses that your product represents.
This means that the company sees the need to design a set of regulations and protocols that allow it to make more efficient use of each of the different resources that it has at its disposal. Already at this point, it is possible to see a fairly approximate concept of opportunity cost.
The economist Friedrich von Wieser was the first to coin the concept of what opportunity cost is and how it posed a constant within the world of industrial-scale production. In his book “Social Economy Theory” published in 1914, Wieser proposes a fairly broad theory specifying what opportunity costs are and how they can materialize within the daily activities that are carried out within the company.
Something that must be kept in mind is that the very concept of what an opportunity cost is is an idea that was born with the heyday of industrial production at the end of the 19th and beginning of the 20th centuries. Therefore, each of the characteristics of opportunity cost and examples of what opportunity cost is are very focused on what is business.
The easiest way to describe the opportunity cost and its relevance within the current economic system is to perceive this law as the estimated calculation of benefits and advantages offered by the rest of the products available in the market, which the buyer renounces. once this makes a purchase effective. In other words, this is a theoretical approach that focuses mainly on what the need to choose represents and the opportunity cost that a company assumes with each of the logistical, strategic and operational decisions that must be taken on a daily basis.
How is opportunity cost calculated?
As it is a theory that is oriented towards the world of finance, it is evident that within the very definition of opportunity cost there is a mathematical formula to calculate the opportunity cost.
If we talk specifically about how the opportunity cost is calculated from a very general perspective, it is as easy as subtracting the benefits of one of the options that have been discarded by the buyer, the real benefit of the product that has been purchased. A good example might be that a consumer in an appliance store prefers to save some money by buying a regular coffee maker; instead of investing a little more and buying the cappuccino machine.
Within this specific situation, what is the opportunity cost for this buyer would be represented by all the attributes associated with the cappuccino machine for choosing a cheaper item. In other words, aspects such as the quality of the coffee, the life of the product and the current market value are just some of the arguments for this consumer to put together an approximate calculation of the opportunity cost of buying it.
Opportunity Cost Applications
This is a very important concept in areas like these:
The easiest way to perceive what the cost of production is is to carefully analyze what an opportunity cost could represent in economics. Since seen from an economic perspective, it is relatively easy to understand why a security is an opportunity.
From how to calculate opportunity cost to the opportunity cost formula itself; everything that is the opportunity cost and what it can represent for a company is directly associated with the area of finance.
Although marketing is a specialty that is not directly associated with Wieser’s law that defines opportunity cost, one must never lose sight of the fact that one of the requirements within marketing is to know the budget allocated for a campaign and develop a system that allows you to get the maximum benefit of it. Therefore, what is opportunity cost is not an entirely foreign concept in all activities associated with marketing and advertising.
As consumers of goods and services, our responsibility is to choose a product that is within the market to satisfy our needs. This action inevitably leads us to a frequent rethinking of our purchase choice, in other words, to a calculation of the opportunity cost of those products that really caught our attention.
Opportunity cost in business
Once we have in mind what the opportunity cost is, it is possible to have a fairly approximate idea of what this economic principle would represent in each of the areas where it could be implemented. But it is in the corporate environment, where all the activities that are carried out have a common objective.
We must always bear in mind that the opportunity cost is directly linked to the purchase decisions that have been made within the company and how these are reflected in each of the departments that make it up.
For a company there is nothing more valuable than its resources, since absolutely each and every one of the main characteristics that are directly associated with a good or service depends on them. This is one of the reasons why the opportunity cost of a product becomes one of the most important data for the company’s board of directors, especially when it comes time to establish the company’s objectives within the market.
When we carefully study the concepts associated with choice and opportunity cost within the industrial context, it is possible to find five divisions that perfectly reflect what the opportunity cost is for a company and how it infers on the activities associated with it. These five categories are represented by:
From a corporate perspective, production translates into the company’s ability to generate enough goods to meet current demand within the market using the resources it currently possesses. Bearing this in mind, we can build a fairly accurate picture of what an opportunity cost represents within the company’s methodology and philosophy.
To guarantee resources for the company, it is necessary to invest capital; and speaking of capital within a company is synonymous with decision making. And from the decisions, we obtain the data to define what the opportunity cost is for the company based on the purchase options and the benefits that are no longer received at the end of the negotiation period with the distributors.
If we focus on what the opportunity cost represents in microeconomics, we have that each of the commercial allies that the company has represents a point to be taken into consideration. Especially when the benefits, limitations and conditions assumed by the company to maintain a healthy and harmonious relationship with each of its partners are carefully studied.
Administration is the most representative department of what an opportunity cost is and what it really symbolizes for the company. Well, if we go to the concept of opportunity cost in finance; We find that the principle behind this theory focuses on the efficient use of available resources.
Although this might seem like a point that is not related to the theoretical principles established by Wieser. If we go to what is the opportunity cost from the perspective of marketing, it is quite logical to understand how the opportunity cost influences the position that a company occupies within the market and how it is perceived within it.
Types of Opportunity Costs That Exist Today
The more we become familiar with the concept of what opportunity cost is according to the theory originally proposed by Friedrich von Wieser, a series of key questions about the current economic system automatically begin to arise.
What is the opportunity cost of economic growth, how does this cost translate into the mass production of consumer goods or why is the opportunity cost perceived as a key factor in the strategic planning of a company. And the way to provide a truly satisfactory answer to each of them is by taking into consideration the fact that within Wieser’s opportunity cost theory this same phenomenon is divided into two categories.
The types of opportunity cost arise as a direct consequence of what opportunity cost is, as economic theory and the very nature of the industrialized economic system. Each of these categories are differentiated by the way in which the opportunity cost materializes through them and what result is obtained from the operational and productive point of view.
Taking Friedrich von Wieser’s own theory as the starting point to understand what is the opportunity cost in the economy; we have that the two divisions that exist within this approach are divided into:
Increasing opportunity cost
An increasing opportunity cost is defined as any expense in which there is no correlation between the capital invested to acquire it and its representation through the objective of the product. Put more simply, it is a constant expense within the company that, in the long run, could end up affecting the production and quality of the goods it produces.
Constant opportunity cost
Also known by the name of Ricardian costs, these are all those expenses that can be replaced within the company by others of equal quality. Making it possible to maintain its same level of production and operability, without having to sacrifice the quality of the product.
What does an opportunity cost mean?
With just a few examples of opportunity cost in everyday life, it is already possible to have a fairly clear idea of what opportunity cost is and how this theory serves as a tool to pinpoint the true risks and opportunities that exist behind each decision.
However, it is logical to assume that there are some specific scenarios where taking into account the opportunity cost represents much more than just a speculative approach to the possible benefits associated with the rest of the call options. From this perspective, what is opportunity cost as an economic phenomenon has a much greater influence in areas related to finance and marketing.
We must always bear in mind that when we talk about theories such as Wieser’s about what opportunity cost is, they are developed around a specific element of the economy. In the case of opportunity cost, this element is represented by the resources and the way in which they are transformed into part of the company’s capital.
And when we talk about the efficient use of resources within the corporate world, this leads us directly to the departments in charge of managing the real resources of the company and the development of communication strategies to increase public interest in the goods and services it offers.
Despite what popular culture would have us believe, the financial area of a company is in charge of managing each of the company’s resources; This includes labor, machinery, business partners and, of course, capital.
When it comes to what opportunity cost is as an economic theory, a crucial part of the finance department is the calculation of operating expenses. And when the time comes to prepare these calculations, it is always necessary to take into account both the resources acquired through the purchase and all the other options that were ruled out once the official closing of the trading period was decreed.
Each and every one of the activities related to marketing represents an expense that has to be covered by the company, whether they are strategies executed by the department itself or a specialized company is hired.
Within the tasks assigned to the marketing department there is more than just designing advertising campaigns, this area is also in charge of other tasks closely related to the product in question, such as distribution and the establishment of commercial alliances. Therefore, within the marketing department it is always important to be very clear about what opportunity cost is and how it influences the budget available to execute each strategy.
Although it is true that Friedrich von Wieser’s theory of opportunity cost focuses mainly on what the expenses would represent and the consequences of each decision made with respect to them, it should not be associated with a controversy regarding how The company’s resources have been well used. What is opportunity cost itself? It is a tool that offers the possibility of analyzing the company’s situation from a much broader perspective and taking into account the strategic advantages of the company’s current resources and how these can contribute positively to its growth.