Opportunity Cost: The Forgotten Cost of IT Investments

Every decision involves trade-offs between the costs and benefits of the available options. But most people forget to account for the opportunity cost of their choice. While most IT investment decision making relies on the traditional accounting cost to decide which technology to buy or what IT projects to approve, it is incredibly useful to incorporate the opportunity cost to improve decision making.

What is Opportunity Cost

Opportunity cost is the value of the next best alternative (forgone) to the choice you have made. Some refer to it as the ‘lost’ opportunity cost because an opportunity cost represents a lost benefit or an unrealized benefit.

Examples of Opportunity Cost

The more commonly recognized form of opportunity cost is the value of not choosing the next best alternative option.

If you only had $100K left in your IT budget to pay for needed infrastructure upgrades or adding mobile learning to your LMS, but not both. Choosing the infrastructure upgrades includes the opportunity cost of not benefiting from the value of the mobile learning. And, choosing mobile learning means the value of the upgrades will not be realized.

In making these kinds of decisions the idea is to consider not only the benefits of the one you choose, but the value you won’t get by not choosing the other.

Let’s say you just finished an LMS RFP and now must decide between the top two options that scored equally for features and price. But one LMS doesn’t create vendor lock-in and fits your existing skills while the other offers many upgrades options and SIS integration. Either choice means an opportunity cost from not choosing the alternative.

Another way of saying this is that by considering the opportunity costs you will determine the downside of not doing something in addition to the upside of doing it.

Another form of opportunity cost occurs when something is not put to its best use resulting in an unrealized value.

A classic example is that most college’s only use 40% to 60% of their ERP software capabilities depending on the module. The value that was never realized from full utilization is an opportunity cost.

Opportunity costs are not limited to direct costs or variable costs or money.

Most organizations consider their people to be their most valued asset. Like all business assets there is an opportunity cost of not fully utilizing the human capital of the organization.

It is also important to keep in mind an opportunity cost can exist from a decision to take no action.

“If you choose not to decide, you still have made a choice” – Neil Peart, Rush

Sunk Cost vs Opportunity Cost

Sunk costs are retrospective and irrelevant to a current decision. But opportunity costs arise from a decision in the present and are relevant.

Shelfware is an all too common occurrence in IT. What you paid for the software is the sunk cost and cannot be recovered. The opportunity cost is the value of the benefits you will not get because it was not implemented.

A more complicated, but common, example many colleges are facing is an ERP system that has cost millions over the years, but college leadership believes is hindering strategic  initiatives. Their decision includes:

  • Do nothing and preserve status quo
  • Address current pain points with some additional modules
  • Re-implement the entire ERP solution
  • Replace portions of the ERP with an alternate product
  • Replace their entire ERP suite with a competitor’s product

In considering the options discipline is required to look past the sunk cost and focus on the present need and the cost-benefit of the options. But that has to include consideration of the opportunity cost from what could be gained by choosing any of the alternatives.

IT Governance Challenge

Too often IT managers and IT governance committees get tunnel vision on the list of proposed IT projects or technology purchases. Maybe all they see is a list:

  • Migrate faculty to Google Apps
  • Implement VDI
  • Replace the commercial LMS with an open source LMS
  • Pilot learning analytics
  • Implement degree audit module
  • Upgrade the SAN for lecture capture
  • Develop mobile apps

Comparing unrelated requests, even with positive ROI’s, can be a challenge. But just because each request can be defended on the merits of an ROI or connection to a strategic goal like increasing graduation rates, how do you objectively determine which proposal is the best use of resources?

So in addition to considering each proposal relative to increasing graduation, you would might also consider the impact on graduation rates by not doing it. This could reveal proposals with low opportunity costs potentially making them less ‘costly’ to deny. It may even help you realize there are non-IT proposals out there that should be funded ahead of your entire list.

This entry was posted in IT Financial Management and tagged , , , , , . Bookmark the permalink.

2 Responses to Opportunity Cost: The Forgotten Cost of IT Investments

  1. Kyle James says:

    Nice article Jerry. Two other areas I’d love to hear your angle on are “Hidden Costs” and Operating vs Capital budget allocations. Both of these have been getting disrupted a lot recently with more and more SaaS/Cloud solutions entering the market. I think that their a lot of hidden costs when school build and maintain their own software solutions that are never openly talked about and often time ignored in the decision process. I wrote this article a while back as it relates to SaaS having much more predictable and easier to understand costs for schools doing an interactive map project. I’m also STRONGLY of the opinion that schools should not be in the software development field from the beginning anyway.

    Also the more people outsource in a lot of ways they are simply moving their budget from capital to operating (lower staff and infrastructure costs for higher services and projects). Their are a lot of not completely understood ramifications in that too.

    So their you go. Your article definitely got me thinking about some other subjects that I’d really be interested in hearing your thoughts about. :)

  2. The Higher Ed CIO says:

    Thanks for the kind words and the suggestions. I have covered the operating vs capital expense before but within the context of lease vs buy which includes a bit on cloud economics. I am working my way through some other ideas to help CIO’s improve investment decision making models by looking beyond the direct purchase price.

Comments are closed.