In (project) portfolio management theory, there are ample publications that will teach you how to make rational decisions about what projects to pursue and which proposals to forego. Such publications are often heavily biased toward spreadsheet-supported models full of number juggling, and as such they bring an air of being solidly based in economic theory.
In such models, the concept of “opportunity cost” features as an element of the decision making about investments. This concept points to an assessment of potentially missed revenue from the next best alternative to the investment that is under consideration. Any calculation of ‘opportunity costs’ is therefore a work of fiction, because if the current investment is going through then the next best alternative will never be realized – the assumption being that there is only so much money to be invested; if that were not the case then there was no need to worry about opportunity costs. The only way to find out if your estimate of the opportunity costs was any good, is going through with the next best alternative.
The use of the wording “costs” is therefore deceptive, as it implies some real disembursement where there is none – this is why I call it a work of fiction, because it points to an “as-if” situation, because nobody is actually paying the opportunity costs – or are they?
In any assessment of opportunity costs, the actual numbers are much less interesting than the assumptions and reasonings behind the numbers. Selecting projects / investments from a set of proposals involves decision making under uncertainty. And where there is un-knowledge, we work with the substitute-knowledge, assumptions and tentative reasonings, to fill the gaps. Even if decision makers are unaware of the extent of their un-knowledge, we can always reconstruct or uncover the assumptions and reasonings they have used to fill the gaps.
So any assessed but not really incurred or firmly measurable costs (or, for that matter, revenues) are an interesting opening into the minds of decision makers – they show us the extent of their un-knowledge when deciding and they tell us how they filled in the gaps. What was assumed about the market when they wrote down that plan B could bring in €7Mio in one year? What reasoning was given for that number, or was it really just wishful thinking, anybody’s guess?
We should not be fooled by the ‘realistic’ tinge of words like ‘costs’ used in a referential manner – they do not exist in the outside world of things, but only in the inside world of people’s heads. That is another form of real, not existing independently from us but being entirely made up of words, that can be undone in a manner that rock cannot be undone.
The very concept of ‘opportunity cost’ has some further feature – it points out an implied ethics as well. The very fact that ‘revenue foregone’ (even if it is fictional) is construed as a ‘cost’ implies that one can somehow be ‘hurt’ by it. Now we should not be surprised to learn that we can suffer from things that are not ‘real’ – as Peter Berger has pointed out “things are as real as they are real in their consequence”. And to be sure, the consequences of using the concept of ‘opportunity costs’ are as real as they can be – some proposed projects get accepted, and others are rejected, all based on reasoning that is full of un-knowledge.
So what more are the implied ethics here? Opportunity costs are part of the next best alternative, and therefore they are really external to the current investment proposal. And in this respect they have a close resemblance to ‘externalised costs’, which are defined as costs that are inherent to some product lifecycle but are not carried by the company or organisation producting that product. Maybe this is stretching the point, but if you think of how ‘opportunity costs’ and ‘window of opportunity’ are related concepts, it could be that the externalised part of opportunity costs is reflected in decisions to stop any further design and improvement of the product under consideration for the sake of time to market. If that should be so, then the consumer of the product is carrying such externalised cost in the form of quality foregone…
So is there an alternative to filling the gaps of our un-knowing with hidden beliefs and implied ethics? No. Or if there is, then it is probably a next best alternative that will never be chosen because of opportunity costs. But we should not let these beliefs and ethics go unnoticed. Bringing them to the surface is probably the fastest way to reduce the un-knowing that they are a sign of – by asking questions, by digging them up from the darkness, by reading between the lines, by inquisitiveness and discernment.