Understanding opportunity, sunk and marginal costs comes with experience, but successful people take them into account from an early age.
A recent blog post by author Seth Godin on understanding different types of cost made me think about how they are applicable to marketing.
Opportunity cost refers to the value of the next best alternative that we let go when a decision is made. For instance, we might decide between spending our budget on a magazine front cover or a getting some videos made. By choosing the videos, which target those investigating a topic, the opportunity cost includes the loss of casual brand exposure that could have been gained from the front cover. Can we afford to lose that opportunity? Understanding opportunity cost helps in making better strategic decisions by considering what’s being sacrificed for a chosen action. It seems obvious, but I’d bet we’re all at least occasionally guilty of neglecting to consider alternatives.
Sunk costs are past expenditures that cannot be recovered. In marketing, this could involve money already spent on an unsuccessful campaign. For example, if we attend a trade show where nobody turns up, it would be a bad decision to attend one with similar prospects just because we’ve spent money on display panels and want to somehow spread their cost. It didn’t work. Get over it. Instead, we should focus on opportunities that can provide better returns, ignoring the irrecoverable costs.
Marginal cost refers to the additional cost incurred when producing or delivering one more unit of a product or service. For example, with search advertising, we tend to start with the most cost-effective keywords, geography, times, etc. If we want to expand our campaign, we have a number of alternatives, but all will probably be more expensive. There’s a point where the marginal cost of conversions becomes higher than the revenue they generate, and we need to bear that in mind.
An understanding of these types of cost tends to come instinctively with experience. However, I’m sure that the most successful people include those who are able to understand these ideas and take them into account from an early age.