Back when I was getting my Bachelor of Science in Economics, I was taught that the true cost of something wasn’t just what you paid for it, but also what you could have had instead of it (the official term: opportunity cost). Another cost concept you learn in Econ is an “externality”–mostly simply defined as a side effect or consequence not reflected in the cost of the goods or services involved. Hmmm, a cost that is not a cost… oh you silly Econ people!
While the words “opportunity cost” and “externality” may make you sound smart, they are such blanket even esoteric terms that they are not that useful when trying to make practical decisions. If I asked you how much your college education cost, you’ll sum up your tuition and books and give me a number. If I asked you about its opportunity cost and externalities, you’ll remind me that your degree was in, I don’t know, liberal arts (something definitely more interesting than Econ), and quickly change the subject.
So let’s put some more meaning and get some more use from the darn four letter word called C. O. S. T.
How will your purchase affect the complexity of your current situation? Will it complicate or simplify things, now or in the future? How complicated will it be to change your mind?
What outcome will you get now and in the future? What opportunities will open up? What will you miss out on? What happens if you change your mind? What happens if your competitor buys first? What happens if you delay your purchase?
What must I also have if I make the decision to buy in order to fully use my purchased item? To learn about it? To maintain it? To upgrade it in the future? To be compatible with others (e.g. clients, suppliers, etc.)? To be legally allowed or certified to use it or share it?
How long will it take to make the choice? To complete your purchase or pay it off? To recoup your investment? To set up (installation, training)? To integrate (configuration)? To adopt (learning curve, growing pains)? How long will it take to start benefiting from your purchase? In the future, how long will it take to upgrade or scale up? How long would it take to undo? How long before your competitor buys something similar and will they have an advantage?
In assessing the items included in C.O.S.T., it is not enough to simply listen to what the seller says is needed or recommended. This goes without saying, but the bigger the sale price, the more research you should do on all the costs related. Check out trade magazines, government regulations, blogs, or forums. Ask others who have used it (ask the seller to provide you with references and then ask them the questions above as appropriate). List out all the benefits (and their values) and the costs; the total costs would be subtracted from the total benefit. It has been my experience that everything takes longer than expected (2 to 3 times more!) and are more complicated than predicted so it is prudent to C.O.S.T. with that in mind. To be more thorough, make minimum and maximum C.O.S.T. estimates. Think of the worst case scenario as where the benefits are minimal and the costs are highest; for the best case, assume the benefits are optimal and the costs are lowest.
There is, however, such a thing as going overboard–costing everything down to the paperclips used, for example. There should be a balance between being comprehensive while keeping things simple (otherwise your mind will drown in numbers!). If the related item costs very little or is a small percentage of overall cost, do yourself a favor and ignore it as it’s not worth the added complexity (see above).
When you’re satisfied that you’re looking at all that pertain to C.O.S.T., how much are you willing to gamble? Are you willing to lose as much as X, for the possibility of gaining Y?
What can you do to mitigate the risks (reduce the costs)? Anticipating C.O.S.T.S. beforehand is a great first step. Simply assuming costs will be less does not reduce risk. Active measures must be taken.
Is this a full proof way to prevent losing money? Of course not. There will always be external factors and surprises will still happen. Most businesses could not have predicted the mortgage crisis.
Spending the least amount of money is not always the answer. Penny wise and pound foolish, as they say.
Assessing C.O.S.T. can help you make smarter decisions and take calculated risks. This is a vital skill for all organizations–for profit and not for profit and everything in between, and for your personal life.
Think back on previous decisions/purchases you made and what happened as a result. Back when you made the decision, did you overlook something pertaining to C.O.S.T.? What would you have done instead if you hadn’t overlooked it?