Question

Opportunity costs are very relevant and need to be considered in a business firm since they can lead to more educated and profitable decisions. Using opportunity costs aids in measuring the benefits a company loses out on when choosing one option over another. If company’s didn’t consider these costs, it could lead to insurmountable losses simply due to making a misinformed decision without weighing out all the options. An example of this would be the example the book (Froeb, McCann, Shor, Ward, & Micheal, 2014) provided in Chapter one when talking about a misinformed bid made by upper management from the company Oil Ventures International (OVI). Upper management should’ve reviewed the opportunity costs from purchasing/bidding at different amounts for the track of oil and how much revenue/value it would bring to the company versus the cost of the bid made. Instead they over bid by 16 Million dollars and cost their company millions since the track wouldn’t bring the equivalent amount back to the company. The formula for calculating the opportunity cost of something is: the return on best foregone option – the return of chosen option (Kenton, 2019).

What could be done differently?

Answer 1

Opportunity cost is defined as the cost of best forgone alternative. Opportunity cost represents implicit cost, Let us try to understand with the following example. Suppose you are a student who has recently received Bachelor's degree. You have two options - either to accept the job offer you receive after obtaining your degree or choose higher education and get enrolled into a Masters program so that you can get a more prestigious and high paying job after completion of degree. Apart from explicit costs like tuition fee, registration fee, etc. which represents the explicit cost, the implicit cost here is declining the job offered after your Bachelor's degree. This is the best foregone alternative and represents opportunity cost of getting enrolled into a Master's program.

Now coming to our question, it is told that top management at Oil Ventures International (OVI) overbid for the deal by 16 million dollars. Thought they might have won the deal, but they to pay this overbid price making it cost their company millions since revenue generated by this track of oil couldn't cover the cost of overbidding. What could be done differently is that the upper management should have careful reviewed the opportunity costs from purchasing/bidding at different amounts for the track of oil and how much revenue/value it would bring to the company versus the cost of the bid made. The alternative which maximized the net profit which is revenue generated from track of oil minus the cost bid should have been selected by the company. This would result in the bid placed being a more educated outcome and company would have not suffered so much losses then.