What is Opportunity Cost
Introduction
Definition : Opportunity Cost
‘the loss of other alternatives when one alternative is chosen’
Many companies are realising, opportunity cost is a very real and underestimated cost to the business and business progression. When calculating ROI, opportunity cost is often discounted as being a ‘soft cost’ and not included in the ROI Valuations.
This document highlights the different opportunity costs that are hidden in our industry and how to calculate their true impact.
My Six Characters
- A : Senior Manager, costs $100 per hr
- B: Senior Engineer, costs $85 per hr
- C: Junior Engineer, costs $50 per hr
- D: Junior Engineer, costs $50 per hr
- E: Junior Engineer, costs $50 per hr
- F: Average business user, costs $70 per hr
We shall use these six characters, over four examples to describe daily scenarios that are costing organisations a significant amount that they may not even realise.
Example 1
Utilising experienced engineers to perform repeat tasks
Every day B comes into the office, gets his cup of coffee and spends 30 minutes reviewing the event logs (Availability, Performance, Capacity). We assume that any availability issues will have been converted into incidents and are being addressed, so B is focusing on warnings relating to Capacity and Performance. B spots that a ‘disk space’ alert has been triggered on a server so he investigates and clears the logs. Sometimes this takes an hour, sometimes it takes more, but for the purposes of this example let’s say an hour.
Daily cost: 1 hour * $85 = $85
Weekly cost: $425
Annual cost: $22,100
However, the REAL cost to the business here is the opportunity cost. While B is focusing on BAU tasks (business as usual), he is not readily available to work on projects. Projects that require his technical and business knowledge to progress. So they are delayed.
Project A: Introducing a new system to reduce the sales processing time from 1.5 hours to 1 hour, impacting 500 Sales people.
Daily savings: 250 hours *$70 = $17,500
Weekly savings: $87,500
Annual savings: $4,550,000
So a project that could potentially save the company $87,500 a week is delayed a week because B is not available to the project.
Weekly cost of fulfilling BAU task: $425
Alternative project benefits requiring resource: $87,500
Weekly opportunity cost to the organisation: $87,075
Example 2
On-boarding a new hire
Hiring individuals can be an expensive and time consuming process across any business department, but especially in IT. We have already identified the opportunity cost to the organisation when key resources are not allocated in an efficient manner and the potential impact to progressive projects. In this example we shall look at the costs of hiring and onboarding individuals.
Let’s say that A spends 10 hours interviewing candidates for a junior position.
Interview cost: $100*10 = $1,000
A’s opportunity cost (lost alternative): $100*10 = $1,000
Total hiring cost (ignoring recruiters cost etc): $2,000
Once we have decided to hire C, B has to train her in. Let’s say in total C needs 20 hours of training.
Training cost of new hire ©: 20*$50 = $1,000
Training cost of new hire (B): 20*$85=$1,700
Opportunity cost (B): 20*$85=$1,700
Total training cost: $4,400
Total hiring cost: $6,400
The figure of $6,400 is actually pretty conservative as we have not included the cost of recruiters etc, and obviously the volume of times we will need to recruit is dependent on the size of the team.
In addition, the productivity of the existing resource who is training in the new hire is not factored into the equation either. This a hidden cost that appears obvious once pointed out but one that is frequently underestimated.
Example 3
Repeatedly fixing the same issue
Let’s say that on Monday, C comes in and notices that the logs on server A are filling up and eating into the disk space, so she cleans them down, on Tuesday her colleague, D notices the same thing and fixes it and on Wednesday, E notices this and fixes it etc.. As different engineers are fixing the same issue on different days, it may take a while before a pattern is noticed. Let’s say that this continues for three weeks and takes an hour a day to fix.
- Cost to resolve repeat incidents: 5*$50*3 = $750
Let’s say that this had been identified in week 1 via ticket analysis, a problem created and B assigned to resolve the problem and it took him two hours.
- Cost to resolve repeat incidents in week 1: 5*$50 = $250
- Cost to resolve problem: 2*$85 = $170
- Total costs to resolve issue in week 1: $420
- Opportunity cost / savings: $330
$330 may not seem like a significant saving, however this is a 44% saving on ONE issue. Extrapolate this out over multiple issues and teams and the opportunity cost / savings are significant. This has not even taken into account any potential opportunity costs associated with having resources working on projects vs focusing on incident management or even factoring in the cost of downtime to our business.
Example 4
End user downtime
No one can argue the fact that end user downtime has a cost impact on the business, but even this real cost has hidden opportunity cost. Imagine that F our average business user has an issue with Gsuite and calls the service desk. F spends an hour working with the Level 1 on resolving the issue.
- Cost of issue: one hour with junior engineer and one hour of Fs time: $70+$50 = $120
However, factor in the opportunity cost to the business — the hour that F has lost working on an ICT issue, instead of focusing on the role that he is supposed to be working on, and the costs go up.
- The True cost to the business is $70+$70+$50 = $190
This is just one example, expand this out to all users and all incidents and the cost of downtime to the business is realistically a lot higher than was initially thought.
Summary
These illustrations are examples, but a common occurrence in our daily work. We as an organisation, recognise the cost of these occurrences, but haven’t realised the additional cost by factoring in opportunity cost.