This is an important issue for me. I think if you understand cashflow you can run a small business, but you need to understand opportunity costs to grow it into a big one. My definition: opportunity cost is what you lose by not making better decisions (Wikipedia) and so being late, or over-priced, or lacking features.
Here is one example of opportunity cost (getting your bees late was easier, but meant less surplus honey)
A swarm of bees in May is worth a load of hay;
A swarm of bees in June is worth a silver spoon;
A swarm of bees in July isn't worth a fly.
And here's another, the Oklahoma Land Run of 1889 (buying a slow horse saved a few dollars, but cost you a chance at getting the best land).
In my experience, opportunity costs are most easily recognized in connection with your capital budget. Board-level management likes to allocate budgets for equipment, to avoid waste, with the result that computer users end up with underpowered laptops, or small monitors, or some dreadful outdated CRM system. This saves money (and improves cash-flow), but has an opportunity cost, because users work slightly slower and waste time whinging.
Note that I am not having a rant about budget allocation as such. I'll leave that to Dilbert. My point is that you need to take "opportunity costs" into account.
Opportunity Costs and Marketing
Opportunity costs show up because you can't spend the same time and money twice.
If you spend money on something like Salesforce, the software has a real cost, but the decision has both positive and negative opportunity costs. Negatives are that you can't do some marketing because you spent the money, and because your people are unavailable while they are being trained, getting up to speed, and configuring the thing. And the positive is that your people are more efficient at the end of the process.
If your marketers do social marketing and "engage" with small numbers of customers, or even individuals (a positive effect) they can't simultaneously work on good mass marketing (a negative effect). Watch out for social marketing gurus who ignore the latter.
You need to calculate these effects - opportunity costs - at least approximately. This is subjective, of course, but isn't everything?
Opportunity Costs and Startups
We all know of startups that began self-funded (bootstrapped); grew to a reasonable size; looked around for venture capital funding; didn't find it immediately; and throttled back - reducing their costs and keeping the startup ticking over.
Unfortunately they can only reduce cash costs - opportunity costs continue apace, because competitors continue working away hard to overtake the startup's product.
Do not get in this position. But, if you do, be aware that you are incurring high opportunity costs and therefore holding out for a perfect offer from venture capitalists is extremely risky.
Opportunity Costs and the Last Bubble
Michael Arrington of TechCrunch has just written a superb article on the Tech Bubble of 1999-2000: We’re In The Middle Of A Terrible Blubble! Read it.
I have one thing to add, which is that I think the bubble occurred because many people miscalculated opportunity costs. They thought that "first mover advantage" advantage was huge on the Internet (I heard many comparisons to the Oklahoma Land Run mentioned above) and therefore there was a huge value in growing your business rapidly, at whatever cash cost. This assessment turned out not to be true, people recalculated, and the bubble popped.
So take "opportunity costs" with a pinch of salt and don't make artificial decisions.
