Next up in our series on highly applicable economic principles is one called opportunity cost. Opportunity cost is the investment your company must make to achieve a sale, and it has a bearing on every company activity associated with a sales cycle. It is applicable equally on the higher level of entrepreneurship as well as at the level of the sales force—which of course includes sales reps and sales management.
Opportunity cost is one of several economic principles that have gained popularity today, but actually originated decades ago with the Austrian School of economic thought.
As with sunk cost the real focus on opportunity cost may not be as important at a company’s startup phase. The importance of initially getting your products or services sold, in use, reviewed and publicly known may very well outweigh the importance of trimming costs, and in the beginning, it probably should.
Shortly after a company is up and running with a client base, however, it should begin paying sharp attention to opportunity cost. It must be figured as precisely as possible, because it will have a direct bearing on your profit margin.
What Goes Into Opportunity Cost?
At first glance opportunity cost might seem simple—for example the pay for salaried employees associated with a particular sales cycle and the cost of trialware or live product demonstration. There are also the ancillary costs associated with sales reps such as company vehicles, travel, entertaining of prospects, computing devices (if the company covers them), and even office space. A company will often offer free tech support to a potential client running trialware or otherwise involved in a limited-time trial of a product or service. The cost of that support and service should be taken into account as well.
But a deeper look reveals other costs that might seem “hidden” but are part of the opportunity cost as well. Opportunity cost must take into account the risk ventured by your company. A good portion of that risk is the time a salesperson spends learning about the prospect company, interacting with decision makers, isolating the potential client’s problems that your product or service will solve, paying personal visits, and everything else a sales rep will do to bring in a deal. While a sales rep is most often paid strictly on commission so is not paid directly until the deal comes in, the time a salesperson is taking on that sales cycle is time not spent on other deals; some of these others may even have a higher probability of coming in or a higher profit margin. That is certainly part of the cost of an opportunity.
For longer-range deals, it often happens that multiple salespeople are involved, and this can be a cost that is missed. In such a case you would have to take into account the items sketched out in the above paragraph for every rep involved with the sale. Also often for such deals, it can happen that other personnel is brought in, such as consultants. There can be an actual monetary investment laid out, such as for special presentation materials put together just for that deal.
Behind all that is the infrastructure behind the rep, which is, of course, means the whole company. While that particular cost may be difficult to totally nail down, it is certainly something to bear in mind. A company is risking a portion of itself in the pursuit of every opportunity.
The sales force is on the front line and is venturing much of this risk on behalf of the company. Hence sales management should be acutely aware of all the costs associated with that opportunity. Opportunity costs should then be made transparent to the sales force in such a way that sales reps can act with them in mind.
Why should the sales force be so aware of opportunity cost? It’s simple: because sales reps are the ones actually making the deals. A sales rep must know the bottom threshold they must not go below in negotiating that deal. Without having opportunity cost data, a salesperson can close a deal for which the company will only break even or—worse—take a loss.
It is evident that opportunity cost is an economic principle immediately applicable to entrepreneurs, the sales force, and sales management—and, in fact, anyone engaged in business.
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