You may have heard the (untrue) story about Bill Gates once dropping a $1,000 note in the street. A passerby pointed this out to him, but he kept on walking on – because it was not worth his time to turn around and pick it up.
The story above simply explains opportunity cost.
What does “opportunity cost” mean? Opportunity cost for the commercial property industry is explained below – in two ways.
You choose, what format works best for you:
2 minute 20 seconds watch
Key take aways
- “Ann and Bob are worse off if they try do everything themselves”
- To watch with your broker lense on, swap bananas with admin, and fish with deals (money).
- Ann is like that broker, who, instead of doing deals (making money), does low value work, like admin. In essence, Bob should focus on banana gathering (admin), while Ann should do fishing (deals).
- Now Ann can get her banana gathering done (admin work), for a third of the time that it used to take her. Because, for Bob, one fish is worth one banana.
- Ann, who can fish 3 times as well as Bob, shouldn’t be gathering bananas. In deal terms, her time is better spent on fishing (making money).
5 minute read.
(Feel free to substitute your name where appropriate)
A broker just like you
A couple years ago there were two enormously successful brokers in Philadelphia. Ferocious competitors, male and female, they were neck on neck on every deal. In the interests of confidentiality, let’s call them broker Trump and broker Venus.
Since this was the property industry, every year each broker would go on holiday for their hard-earned one month break. And every year they would return recharged, ready for that year of battle. Battle would involve almost 11 hyper-competitive months of always-on, 200 hour work months.
One year, everything changed. Broker Venus, slightly younger, went away to Martha’s Vineyard with a family friend who ran an enormously successful family manufacturing empire. Let’s call that family friend Rockefeller. After some deep conversations with Rockefeller, plus thinking and reading, she came back early. And, while Broker Trump was still on holiday, she started working.
This was the last year she would ever work more than Broker Trump.
For the first time ever, Broker Trump, blissfully relaxing in the sun on holiday, was in trouble.
When he came back, unknown to him, Venus was no longer fighting a fair fight. The rules of the game had changed…
A chat that changed how Venus saw business
You see, while on holiday, Venus had a conversation with her old wealthy friend, Rockefeller, that changed how she thought about work forever. Rockefeller explained to her the concept of “opportunity cost”. This “secret sauce” had been passed down from his father, and from his father’s father.
Venus knew it by other terms such as “working smart not hard”, but had never had someone take the time to explain it to her, applying it to her CRE business.
The conversation went like this, during one morning of unproductive fishing:
Rockefeller: “You know, I’ve always wondered how much a good broker earns?”
Venus replied, giving her earnings range, talking a bit about the hours she works, and adding the fact she is a people’s person, and really enjoys her work.
Rockefeller, surprised Venus with his response. He laid down his rod and said with surprise: “Heck darn it! This is incredible. You earn more than 90% of my CEOs! And, I employ the best, and pay the best.”
This was all of a sudden a way more interesting conversation topic than Rockefeller had thought…
Why CRE professionals are like doctors
Rockefeller, now curious and a lover of all things business then asked: “What would you say is your most valuable asset?”
No one had ever asked her this before. Venus replied, taking various stabs: “My relationships”, “My skills”, “My reputation”. After a bit of conversation, Rockefeller each time, dug more.
Eventually Venus, running out of options, said: “My time”
Rockefeller, slowly and confidently: “Yes, I would agree… As I understand it, you’re like a doctor. You actually sell time. And you have only so many hours a day. You are in a daily race. Your time is your money.
Rockefeller, now warming up: “Okay, so let me ask you two questions. One, have you ever been explained the concept “opportunity cost”. And two, what daily activities bring you your money?”
Venus, said no to the first, but replied assertively on the second question – she was at the top of her game: “Being in front of clients, building relationships by showing how I can help. Having the best data, knowing my stock and gathering industry intel” Proudly she added “My efficiency too”
Rockefeller: “I hear you. Now, what daily activities take away from this time, and cost you money?”
Venus had never been asked this unusual question, but again she was fairly confident. She had a laundry list of tasks she was very familiar with: “Managing data. Running deals. Reporting on deals. Communicating to clients. Making phone calls to check my information is correct. Chasing vacancy schedules. Putting together brochures. Sitting in long deal meetings. Checking data”
Rockefeller, smiling, his efficiencies-obsessed, titan of industry engineering brain starting to like what he was hearing: “Okay. So your job involves, lots of admin. Before the next question, can you check some sums for me?”
Opportunity cost – what the successful know
“So I understand you earn let’s call it R11M per year. And you take 1 month a year off. So you earn R1M every month”
Venus nodded, realising she had never thought about it like that. She was comfortable talking about these numbers – Rockefeller was like a big brother to her.
Rockefeller continued: “And you said early on you work 200 hours a month”, shaking his head almost in disbelief as he said the next part “Only – for that amount of money”. Then he asked: “What is your productive hourly rate?
Venus, quick with numbers, shot back: “That’s easy. R5,000 per hour”
Rockefeller, now with a gleam in his eye: “Nice try, but no… How many hours are you productive and how many hours are you doing admin? Let me ask it another way? When you are doing admin, are you earning money? How much time do you spend doing avoidable admin?”
Venus, thought. There was some admin she alone was best positioned to do – that was her competitive advantage, and she did not shy away from it. …But there was also a large chunk of admin that she could avoid: “Roughly 40% of my time every month”
Rockefeller: “Okay, so my maths has you only productive 60% of the time, or 120 hours a month”
Your actual opportunity cost
She felt a knee jerk pang of indignation – she worked hard – she wasn’t a slacker! After this subsided, a thought bubbled into her head… Everyone had always accused brokers of being lazy. Not wanting to do admin. Venus hated most of her admin. …But all along she had been right! Her sense that admin was not her friend became clearer to her, and she excitedly blurted this realisation out to Rockefeller in a stream of words.
Once the talking had ended, Rockefeller summarised “This perceived laziness is hyper-rational. You have sub-consciously identified that your time is your big constraint. You seek to optimise your time” Sometimes he spoke like that – standard probably for someone with an MBA from Harvard. But she understood fully, nodding.
Venus, doing the maths on her phone responded: “So my productive hourly rate is not R5,000 an hour, but actually R1M monthly earnings divided by my 120 productive hours a month. This gives me R8,333 an hour” She carried on “In fact, those 80 hours of avoidable admin, my 40% unproductive time, drags me down. Those hours take me away from doing the work that earns me the money”
Rockefeller chipped in: “Your opportunity cost of doing avoidable admin is R8,333 an hour”
Now Venus had momentum. She was fired up!
“So basically, if I can find something to take care of my admin work, I would have 80 free hours a month. To do more deals. In fact, 80 free hours at R8,333 per hour equals R667K per month” Shaking her head in wonder: “Working the same 50 hour weeks, I could earn R1.7M per month, instead of R1M” She continued, “That’s an extra R7.3M a year!”
Now what? Step 1 – automation tools
Rockefeller, the engineer, enjoying this: “That’s it. That’s what business is all about” He was proud of his family business, so he went on: “Our people are our most valuable asset. Understanding opportunity cost, we spend a lot of money on solutions to help these skilled people do more of their core work they are good at”
Continuing “Automation tools do the grunt work for my guys. And we hunt for processes that could be better done outside of our factories by cheaper specialists. And, when we find it, we send that work outside – i.e. outsource”
Venus posing the question: “But doesn’t that cost extra? Doesn’t that eat into your profits? Surely this means your expenses are higher than your competition’s? That’s not sustainable”
Rockefeller, laughing: “Definitely in some parts our expenses are higher than our competition. But our revenues are also higher, and we make bigger profits! We take business from them, because we have the tools to operate faster and better. While they work harder every day treading water”
This guy is just as competitive as me, Venus thought to herself, smiling.
Rockefeller: “And to answer your question. Yes, the tech tools cost extra. But let’s do the maths. If tech saves one of my guys 15 hours a month, and he’s bringing in R400 an hour, how much extra can he earn?”
Venus, doing the maths: “R6K a month extra”
Rockefeller: “That’s right. Now focusing on just the numbers, and ignoring the other benefits, if that tech tool costs me R2K a month, am I winning or losing?”
Venus, quickly: “No, you’re winning. By R4K. Not changing has a monthly opportunity cost to the business of R4K” Now Venus, throwing some MBA-speak back at him: “That means you get a 200% return on your expenditure. You’d be crazy not to”
Step 2 – Outsourcing
Rockefeller nodded. She got it. Rockefeller continued, talking now about his other secret weapon: outsourcing “Outsourcing helps you to focus, and to avoid being a Jack of all trades. If your core business is relationships, advice and deals, you can ask yourself are there are any moving parts to your business you can eliminate?”
Rockefeller paused, “Let’s do the maths: say you employ people at say R200 per hour shuffling paper 50 hours a month. This costs you R10K. If you can get that same paper shuffled at say R6K per month, what does that do for your bottom line?”
Venus, nodding: “It adds R4K on to my profit, every month… I get it. I like it.” She continued, “However, once Trump knows what I’m up to, he’s probably going to try figure out what my secret sauce is. He’s a crafty operator”
Rockefeller, laughing. “Funnily enough, that’s exactly how my dad first figured out outsourcing. From a competitor who was knocking our socks off a long time ago – but that ended quickly! That’s how business works. But, the difference, once we knew the concept, we implemented it. Lots of people know these things, but, for many reasons, don’t act on them”
Venus knew this too well. Rockefeller added a Drucker quote his dad liked:
“Plans are only good intentions unless they immediately degenerate into hard work”
Venus, bright as a pin, continued, summarising: “So let me check I understand. Now that I know what my actual opportunity cost of time is, I can look differently at my business. I can find time-expensive tasks that I can either a) automate, or b) outsource”. Venus’s MBA-bingo game was getting stronger by the minute. “If my cost to outsource or automate is less than my opportunity cost of time, I am winning!”
Rockefeller: “100%. You have it. Provided you do use the extra hours freed up productively. Don’t fall into the trap of getting the gift of precious time, without using it!”
Venus, laughing: “You don’t need to worry about me thanks – I won’t. I love what I do, and I have become used to working 50 hours a week. The freed up time means I can do more of the work I love, and less of the work I don’t love”, she went on
Despite this, Rockefeller had one request: “Do me one favour. Keep this concept cost between us. Not everyone knows and understands opportunity cost. If my competitors were thinking like this, and doing the maths, there would be less relaxing here and certainly smaller profits”
Venus nodded, thinking already about the steps she wanted to take to make her business more efficient. Equipped with the concept of opportunity cost, and seeing things differently, her planning mind was now in full swing. A system to look into to automate processes. Finding ways to get non-core tasks like data management outsourced. And, at long last, those projects her back office team members could start now that they would have more time.
Did the theory work out in reality?
You are probably wondering how Trump did against Venus that year… Well he actually started off stronger. It took Venus a while to get her head around these new concepts of automation and outsourcing. There were some teething problems in the beginning. This brought doubts – Venus didn’t like change, and started questioning the applicability of engineering concepts to the CRE industry.
Her enthusiasm wore thin. A phone call went out to Rockefeller. He knowingly told Venus to persevere. And reassured her that taking your business up a gear is never easy. The first quarter of that year was tough…
The second quarter felt like the teething problems were finished. The new processes started feeling a bit more comfortable. Things started clicking into place. Venus stopped doubting, and started trusting the process. Rockefeller got a cautiously optimistic thank you text. But still she was neck on neck with Trump.
That year was a tale of two halves. The next six months were a whirlwind. All the initial pain was forgotten, and Venus was surprised how her perceived small advantage was resulting in outsized big wins. Work was fun, she was having fun, and she had her two best quarters ever. At year end Venus left her office the day the industry closed, while Trump kept on working.
Fast forwarding to the next industry holiday, two years later: this story ends well. Trump is one of Venus’s best performers, and he’s happy. His expenses are lower, he’s more efficient than before, and he’s taking home more than before. The clients in Philadelphia are happy with the excellent service. Venus’s big bet has paid off.
And she’s back in Martha’s Vineyard, the place where her success truly kicked off. She’s still picking her friend Rockefeller’s brains. This time it’s for which holiday home he recommends she buy.