Opportunity costs
How to not fail.
Today I want to write a bit about how to think about maximising your time. This is an extension of the post Test, Don’t Debate1.
In startups, your desired outcome is usually survival. In more established businesses, it’s how much more money you can make.
Since I closed my startup, I’ve audited, assessed, or coached over 200 businesses looking at growth, and I’ve worked very closely with 50 or so.
I’ve started to notice that there are a few characteristics within teams that are holding people back.
Often people talk about “focus”, but it’s become so repeated as to be meaningless.
To be able to focus properly, you need to understand opportunity cost, expected value, loss aversion, ROI, and future cash flows.
And so today, we will learn a little bit from poker, behavioural science, and finance, to hopefully all help some better decisions and increase our chance of either survival or fortune.
“We believe that a fundamental measure of our success will be the shareholder value we create over the long term”
The first subheader in Bezos’ first ever Letter to the Shareholders is entitled “It’s all about the long term.”
It’s funny, when people criticise “growth at all costs” they often do so in conjunction with calling it short termist. In fact, it’s the opposite – it’s about creating future long term value at the expense at short term gains.
He goes on to be explicit in what that means:
“When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows”
I didn’t study business or accounting. I studied English with a distinctive side of nerdism that had me building computers and learning C++ at 11 years old. So for me, a lot of this stuff is stuff I’ve learnt over the last few years.
The concept of “future cash flows” is important. It does what it says on the tin: it’s the consideration of how much cash you’ll make in the future.
For Bezos, there were many years this philosophy was really tested, but ultimately it’s paid off remarkably well.
A pound today is worth less than a pound in the future.
There’s a financial principle known as the time value of money. This states that waiting to receive money is bad because if you had the money today, you could be investing it to create more money.
This is why interest exists: as compensation for not having that cash available today.
As business owners and founders, or even existing teams, perhaps we don’t naturally think like this. But all money that gets invested into something could also be invested into something else.
Within businesses themselves, it can become quite abstract.
For a start, founders and founding teams are heavily exposed to the mechanics of how well a business is doing, but for most team members they’re often quite detached from the reality of the business.
I’ve been advising friends, ex-employees, colleagues for years to ask interviewers’ about the financials of the company. If you don’t get good answers, that’s a flag. For a starter if your boss doesn’t know, then that’s a flag on them, and if they’re cagey that’s a flag too. This is your future after all.
I do get the alternative view. After all, entrepreneurs are particularly risk-loving people. They have chosen to be exposed to risk of their business failing. Most people are not entrepreneurs and value security over the upsides of entrepreneurship. And so I get the view that you should shield some team members from some realities.
But for senior team members, and any employee super early-stage within a business, you are inheriting some of that risk whether you’re conscious of it or not.
Time is money
People are reasonably good at understanding literal pounds being spent.
I’ve seen people wince at £1,000 being spent on Meta in the early days. Or £500 on a printing error that had to be corrected. Or the 2.5% of every transaction that a billing partner takes.
I’ve also seen very smart people obsess over reduction of those costs: finding the saving of £49 per month.
But what people are not inherently good at is understanding that every minute of their time is also money.
First you have your cost of your time, which we can calculate like this
Let’s assume 15% NIC plus another 5% in pension contributions plus another £12,000 per year for other costs (office, equipment, training etc). Divide that by the 260 working day year and 8 hours of work a day and you’ve got actual cost of time.
But now we have to consider the future value of that time.
What are the list of jobs that could be sat on your desk today in an early-stage business? Let’s assume you’re the early-stage founder of a team.
Negotiating a discount with a supplier from £6,000 down to £4,500
Responding to all queries on FB comments
Spending time checking your Facebook Ad account because its addictive
Putting together investor updates
Putting together a new contract for your staff
Interviewing intern candidates
Now some of these have immediate cash value (if we can get discount down from £6k to £4.5k and that takes 3 hours of negotiation.
Let’s assume my hourly cost to the business is £90.
£1,500 return on £270 of cost is good (5.5x and highly likely to happen).
Loss aversion getting in the way
The discount negotiation is easy for a few reasons.
The cash value is right there.
The ROI value is right there (if you do the hourly calculation)
Humans are predetermined to avoid loss, more than chase upside.
The third one is a behavioural science principle, where most meta studies actually reveal the ratio of loss-to-upside is usually 2:1, that’s how powerful it is for us.
But is it the right one?
How expected value and probability reveal better opportunities
Let’s say you spend 3 hours prepping investor updates and that costs the business £270. No immediate return and maybe it feels arduous to you at the time. But in eight months time, you might need to raise again. By now you’ve spent £2,160 of your time doing this work.
Now currently just 13% of companies manage to progress from seed to Series A.
Now let’s assume those 24 hours of time you spend, increase your probability from the 1-in-7 industry average to 1-in-6.5, and that helps you go on to raise £4m.
Expected value
Expected value is the average outcome if you could repeat this situation many times. It's calculated by multiplying the probability by the payoff.
And so here’s how you’d calculate the above:
Without the updates: you'd succeed about 143 times (14.3% or 1-in-7 chance)
With the updates: you'd succeed about 154 times (15.4% or 1-in-6.5)
That's 11 extra successes (the improvement)
Each success gives you £4 million
So over 1,000 attempts, you'd gain an extra £44 million
Per single attempt, that's £44,000 on average
Now, you invested £2,160 of time into this.
That gives you an ROI of 20.3x.
Over 4 times more return than saving £1,500 with that supplier.
Practical ways to get better at forecasting
You’ll notice with this example we had to make a core assumption which was ‘what does our probability increase to, if we were to perform an action?’
My 7% increase in likelihood to raise is most likely incorrect. I haven't studied fundraising dynamics enough to understand the precise impact.
Getting good at understanding how different actions improve likelihood of success is hard. But getting good at forecasting is a skill you can practice.
Think of it this way:
Take a look outside your office. How far do you think it is to the end of the road?
Go actually measure that distance.
Now repeat the process with another destination
Your repeated process will be much better as you’ve built up the knowledge of what 300 metres might look like.
You can apply that to everything in work too.
In short, to get better at forecasting, start. Do some of it, measure it, and then try again.
Running a business is hard. It’s a constant process of balancing risk.
But while I see people obsess over saving pounds, they are far less likely to obsess about both time and opportunity.
Time is money. That's not a boring adage that's cynically bandied around Wall Street, that is reality. Every unit of time spent has an impact on future cash flows.
What are you doing to try to maximise that chance of success?
Test, don't debate
Today, I want to talk about the cost of time and why testing is so much better value money than you think it is.