Business ownership requires many tough decisions — how to spend money, how to market to customers, which types of software you should choose, and more. Each decision that you make has opportunity costs, as well as the potential to affect your business. In this article, we will discuss what opportunity costs are, how they affect your business, and what you can do to reduce them and help your bottom line.
What are Opportunity Costs?
Nothing in life is free, including the decisions that you make for your business. Every time you make a decision, a business resource must be given up. This can include your employees’ valuable time, land, money, and other resources. However, opportunity costs are necessary to improve your business and make decisions. To find the balance between opportunity costs and solutions for your business, you must first understand how they can affect your business.
How do Opportunity Costs affect my Business?
Let’s pretend you receive an email from a client about your services. You look over the email, call the customer, and speak with them for an hour about the services they will need. You also perform a credit check to determine whether you should give them a line of credit or require payment upfront. Finally, you clear an afternoon to meet with them. The opportunity costs associated with this situation are the hour spent on the phone, the money spent on the credit check, and the block of your schedule that has been cleared for the meeting.
Unfortunately, on the day of the meeting, the client calls and informs you they need to cancel. They also do not sound enthusiastic about rescheduling, leaving you to believe they are no longer interested. You have just lost your time, some money, and an afternoon that could have been scheduled for other clients. Even a minor decision, such as contacting a customer about services, can affect your business.
Perform a Cost-Benefit Analysis for Each Option
When you are evaluating possible options for your company, it is just as important to look at the benefit as it is to look at the cost. The best way to decide is to perform a cost-benefit analysis for each option. A cost-benefit analysis compares potential costs and benefits in terms of dollar values. In the previous scenario, you would have to put a dollar value on the time spent prepping for each client. However, you would also have to weigh the possible revenue generated from a long-term business relationship with a client against those costs. This is a situation where the reliability of a customer can be very influential in the cost-benefit analysis. If you cannot perform this analysis for your company, hire an accountant or financial analyst to help.
Implement Policies to Protect Company Assets
There are several different policies you can implement to prevent the previous situation. First, you could require potential customers to provide payment information upfront. When doing this, be sure to use a trusted third-party source to transfer money. This can ease a customer’s discomfort with turning over their money when they have not yet received any services. You can also implement a cancellation policy that requires customers to provide a set amount of notice or pay a small fee. This fee can be used to cover some of the costs incurred while qualifying your lead.
Keep Customer Payment Information on File
You can improve the reliability of customers and reduce the likelihood of late payments by keeping your customer’s credit card or bank account information on file. This can reduce opportunity costs because it decreases the chance of customers not paying on time. You can even consider automating payments so the accounts are always paid on time.
When you make decisions for your company, you must also consider how the technology your company uses can influence the decision. If you are choosing new software, for example, you must consider whether or not it is compatible with the current hardware in the company. You must also consider how complex the software is, how long it will take to train employees, and how likely it is that the implementation will be successful.
Consider the Role Employees Play
Another way to reduce opportunity costs is to remember how employees will play into each decision that you make for your company. In the previous example, if you plan on delegating future customer relationships to employees, you must consider the number of hours they will spend researching this customer’s business.
Another example is implementing a new process for tracking employee hours for payroll. Let’s say your current system requires employees to punch a card. This has the risk of employees punching in their friends’ cards or employees forgetting to punch in and out. You are now evaluating the decision to implement a new system — an RFID badge system or a system that uses biometrics to track employee activity. The badge system could work because employee badges are not easily accessed by other employees, reducing the risk of fraud. It also leaves some trust with the employees. A time clock requiring a thumbprint would likely be very expensive to implement. It would also leave employees believing you do not trust them, which could reduce their enthusiasm to do well at work. For this reason, the badge system would most likely be the best option based on the cost-benefit analysis.
Evaluate Where You Can Share Resources
Sometimes, you may find that you can split resources between two or more areas to reduce opportunity costs. For example, you may make the decision to purchase accounting software and free up time within your company to be used in other areas. However, you may find that new hardware is required to be compatible with your software choice. Once you purchase the hardware for one type of software, remember this is a potential cost advantage that can be used with future software purchases. Another example is the purchase of land. If you purchase a large piece of property, you may be able to use part of this land to store resources, another part as a warehouse, and a portion to manufacture your product.
Contracting with a Single Company for Multiple Services
Another way you can reduce opportunity costs is by working with companies that offer several services or coordinating themselves with other companies to offer you a wider array of services at a reduced cost. For example, if you are looking for a cost-effective payment gateway, you could consider working with a business like Fattmerchant, which provides additional merchant services such as account management software and point-of-sales equipment. You can also consider working with affiliated businesses — they may offer a discount for choosing to work with both companies.
Spend Your Company’s Time Wisely
You only have so many employees, whether your business is small or large. This can become a problem if you simultaneously take on too many projects/customers. You may have to turn down otherwise great opportunities because you already accepted lesser projects and no longer have the manpower to handle them. To reduce opportunity costs in this situation, manage the time your employees spend on each customer wisely. Try to leave enough time to accept new customers, but be sure you do not schedule with more clients than your employees can handle. Additionally, consider automating processes within your company. Automated processes allow for more time to be spent working with customers and less time spent doing tedious tasks such as billing, filing, and generating reports.
Invest Money Wisely
The final way to reduce opportunity costs is through wise money investment. Consider the example of having to forego a project because you had already taken on too many clients. In this example, you could require the new customer to put down a deposit for this large project. With this deposit, you could hire a new employee or two to help handle current or even new projects. This extra manpower can be used to allow you to take on this customer and more customers in the future. This wise investment can lead to an increase in revenue and profitability.
About the Author: The writer of this article, Lautaro Martinez, is a small business owner who often writes about small business topics to help owners minimize costs and maximize revenue.