How Outsourcing Can Help You Overcome Opportunity Cost Cognitive Biases

Shaunvir Mahil June 13, 2018

Correctly estimating the size and value of the opportunity costs of your business is an incredibly difficult endeavour, but critically important for its success.

Behavioural science tells us that humans are hard-wired for loss aversion and to over-estimate the value of what we already have ‘in our hand’. As a consequence of these cognitive biases, I believe, most people have a pre-disposition to focusing on gains/losses that are more immediate and tangible than more distant opportunity gains/losses. Let me give an example (a silly hypothetical example I admit, but it should make the point).

You are a small business owner, and your company’s turnover is $4 million dollars per annum. You had a long day at work and upon arriving home and opening your mailbox, you discover that your mobile operator has mistakenly overcharged you by $50 on your last bill. It’s already late and you only have one hour before you go to sleep. What do you do? (By the way, this particular call center is open 24 hours a day). Call centers are notorious for such inquiries unnecessarily getting dragged out (well, in my experience anyway, anytime I ring up a call center, I am amazed at how I end up wasting 20 minutes).

So, say it will take you between 30 minutes to 1 hour to resolve this issue (you might have to call back to chase up if the refund is not initiated or if the operator disputes the overcharging etc). What would you do? Call the call center? Of course, it would be quite reckless to just let $50 slip so easily, right? It completely goes against our nature, especially when it is a mistake on the part of our service provider. I would suspect most individuals in such a situation would make the call. But is your time really worth $50 an hour? As the owner of a business turning over $4 million dollars per annum, I would suspect your time is worth more than this.

Could your time be better invested? Would your time be better invested, in say, reading a book? The knowledge you will gain from reading a book will last a lifetime, may significantly change how you approach a business problem and can be applied multiple times throughout the rest of your career. If we apply the ‘compound effect’ formula to knowledge, given your position as CEO (and hence the impact you can make), I think the value of reading a good business book far outweighs the value of $50.

You may agree and some of you may disagree. If you are of the latter opinion, we can change the hypothetical scenario; would it make more sense to do an additional hour of work from home or chase up on an incorrectly charged $50? If you make more than $50 an hour, we all know that working an additional hour from home is financially better for us than calling up the mobile operator.

But despite this, letting go of those $50 is a very painful even though we know our time could be put to better use (again, let me reiterate this is a silly example, some of you may contest that you can call up the call center on another day when you have more time etc. But time is still time and even say on a weekend you could invest your time in reading rather than calling up a call center. Let’s not worry about the example itself). The question we must surely ask is, ‘why’?

I believe it is because the $50 is concrete. It’s very tangible, whereas the opportunity cost gains of reading a book (or say even doing an extra hour of work from home) are incredibly intangible with the gains to be experienced in the far distant future.

How we perceive opportunity cost is what I believe is one of the most important traits in distinguishing entrepreneurs from non-entrepreneurs and highly successful entrepreneurs from mediocrely successful entrepreneurs. Most of us succumb to focusing way too much on the immediate gains/losses right before us. The best entrepreneurs possess the ability to identify highly valuable opportunities, which the most of us simply would not recognize or perceive. It is not that the best entrepreneurs are necessarily more hard-working, it’s just that they put their focus and time into projects that give higher returns, whereas the rest of us don’t even know that such opportunities exists.

I would go so far as to say that this cognitive bias is so extreme and insidious that it is dangerous. This is best epitomized in The Founder, the Hollywood movie based on the life story of McDonalds Corporation. There is one scene in that movie that had sent shivers down my spine. It is a scene where one of the McDonalds brothers is wasting time and energy ‘flaffing and flapping’ around over the ‘perfect temperature’ at which the fries should be cooked. The McDonalds brothers had missed the point altogether. They were investing all their time and energy into ‘perfecting what already was a perfect kitchen’, which was going to add only marginal value to their business.

What they should have rather been doing was expanding and franchising their unique business model as Ray Kroc correctly identified. Ray Kroc saw the bigger picture. He saw that the opportunity cost gains of getting out there and franchising McDonalds was significantly more valuable then standing in the kitchen and contemplating if the fries should be cooked at a temperature half a degree higher.

I took two key lessons from that movie scene. One, you can create as much work as you want for yourself; just because you are working hard does not mean you are really working, that is, adding real value to your business. The McDonalds brothers were working just as hard as Ray Kroc. The only difference was that the brothers were investing their time and effort into projects that would (if successfully implemented) bring returns in thousands of dollars and Ray Kroc was investing his time in projects that as we all know resulted in billions.

Two, and more importantly, you can have an absolute goldmine of an opportunity staring you right in the face and you miss it because you are so caught up and engrossed in what is immediately and tangibly right there in front of you. In my humble opinion, the mistake most entrepreneurs make is to focus on the ‘fries’ rather than the ‘franchise’. If you don’t make a conscious effort to accurately calculate the opportunity costs in front of you, it can be very dangerous because you won’t feel them and significantly underestimate them despite their magnitude – just as the McDonald’s brothers did.

As business owners, it is critical that we identify that it is very easy for all of us to succumb to this cognitive bias, to ‘no longer see the wood from the trees’ and the ‘bigger picture’.

But how does any of this relate to outsourcing overseas and how can outsourcing help us overcome these cognitive biases?

There are two answers to this question. First, of course, as I have already mentioned, appreciating the magnitude and value of an opportunity is very difficult. Something can be worth millions and simply won’t realize it. However, that is not the complete answer. Another reason why we miss opportunity costs is because of risk, a fear of failure and getting into a comfort zone. This is particularly true for established businesses.

We are making a healthy profit, why potentially jeopardize all of that by taking a punt on a new vertical or project? I may have a great idea, but do I really want to invest $300,000 to try it out, when things are ticking along just fine as they already are? The McDonalds brothers were doing just fine, they were in control of their business and they were worried that franchising would result in a drop in standards. Fear is what stopped them from franchising.

I do believe there is an immense amount of potential trapped and lost within a significant portion of small to medium sized established businesses. The reason I believe this is simple. Most small to medium sized businesses simply are not renowned for innovation. Most of them are rather ‘run of the mill’. Only a minority of companies dare to ‘push the boat’ and keep experimenting.

In my last blog post Why Hiring Locally and NOT Outsourcing Often Hurts Local Job Creation, I looked at why outsourcing, despite how counterintuitive it seems, is often responsible for local job creation rather than job loss. And that if we want to create more jobs locally, we should focus on creating a culture of high experimentation and innovation. Can outsourcing to India help us make this cultural shift and seize more opportunities?

Outsourcing allowed us to explore new technologies

I would advocate that it already is, as the following example from Olivier Cant, (CEO of Exxoss, a Belgium-based Infrastructure-as-a-Service company) demonstrates:

However, this is not to say that outsourcing cannot play an even greater role; provided more CEOs identify the link between outsourcing, opportunity and innovation, that is, because outsourcing reduces your risk (lower cost, no long-term contracts and quicker time to market), entrepreneurs will no longer have to overly worry about trying new projects. If those projects fail, it’s not the end of the world, nor is there any collateral damage. Hence, the equation is very simple. The more you experiment, the less opportunity cost loss.

Secondly, even if we make it easier for us to experiment, opportunity costs, as mentioned earlier, are still notoriously difficult to accurately estimate. This is because intuitively (read Thinking Fast and Slow by Daniel Kahneman), we are terrible at calculating compound interest. Would you rather have $3 million dollars today or a single penny that doubles for 31 days? Intuitively, I want the $3 million dollars, but I would take the penny (only) because my maths teacher was good at explaining the power of compound interest when I was at school. The problem with business is that your maths teacher is not there to tap you on the shoulder and put into perspective just how much is at stake, or rather is being ‘lost’ by leaving your projects on the drawing board to gather dust.

What we thus need is a hack because approaching the problem head on and getting better at calculating the compound effect of un-launched projects is not easy. However, we can seize more opportunities if a) we get through our projects faster b) delegate and streamline your work so that you waste no time on non-revenue generating projects.

The more we get done, the more we are able to do. Outsourcing helps us in both these areas. Firstly, hire more manpower so that you can get through your projects faster. Secondly, it ‘clears your plate’. For example, time and time again, I have seen clients tell us that they don’t want to consider candidates we have ready today, but rather see how things go with their recruitment efforts locally. This to me is a prime example of letting opportunities go to waste.

We often already have the solution clients want and need, but they would rather spend weeks and months of their time and money recruiting locally. And it is not just HR managers. More often than not, it is the directors that are making these calls. The point that seems to be missed is that recruitment is not a mission critical project. Every hour you invest on recruitment is an hour taken away from other projects that you could be doing.

Of course, it is important to ensure that the ‘fries’ are cooked at the right temperature, but if you compare it to the size of the ‘franchise’ opportunity, there is no comparison. Is this why most small business stay small and can outsourcing ‘clear our plate’ to such a degree that we have more time to start new projects that otherwise would easily get postponed?

In conclusion, the advantages of outsourcing extend much further than those we typically envisage. What decision makers should increasingly be doing is having a closer look as to how they can utilize outsourcing to increase innovation and also take into consideration the role that outsourcing can play in helping us overcome irrational decision-making.

To learn more on this topic, click here to read: Does Hiring Remote Staff Prevent Cognitive biases & Mission Creep?

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