Opportunity Cost Neglect

4. Considering what else you could do

In the early 1990s, Shane Frederick, then a graduate student, was shopping for a stereo in Vancouver, and he found himself “frozen in indecision” between a $1,000 Pioneer and a $700 Sony. He ended up spending almost an hour agonizing over the decision until finally a salesman approached him and asked a question: “Well, think of it this way—would you rather have the Pioneer or the Sony and $300 worth of albums?” That question broke Frederick’s mental logjam; he decided to buy the Sony. The extra features of the Pioneer were cool, he figured, but not nearly as cool as a bunch of new music.

That day in the electronics store landed Frederick a new stereo, but it would also, later in his career, spark a line of research. At the time he was stereo shopping, he was getting a master’s in environmental studies, but later he switched to a PhD program in decision sciences. Recalling his stereo experience, the first experiment he conducted as a doctoral student explored the way consumers think about opportunity costs.

“Opportunity cost” is a term from economics that refers to what we give up when we make a decision. For instance, if you and your spouse spend $40 on a Mexican dinner one Friday night and then go to the movies ($20), your opportunity cost might be a $60 sushi dinner plus some television at home. The sushi-and-TV combo is the next-best thing you could have done with the same amount of time and money. Or if you love both shopping and hiking, then the opportunity cost of a Saturday afternoon at the mall might be the forgone opportunity to hike through a nearby park. Sometimes you’ll be offered an option with a very high opportunity cost—for instance, if we invited you to our “neighborhood sing-along” on the same night as the Super Bowl. Assuming you are sane, you will turn down our invitation, because its opportunity cost is too high.

The stereo salesman’s question was a classic prod to think about opportunity cost: For Frederick to buy the $1,000 Pioneer stereo meant that he was sacrificing the chance to buy a $700 Sony stereo plus $300 worth of music. It intrigued Frederick that it simply hadn’t occurred to him to think that way. Some economists take it for granted that consumers make these opportunity-cost calculations. One journal article summarized the typical assumption: “Decision makers confronted with a showcase of beluga caviar consider how much hamburger they could buy with the same money.… People intuitively take opportunity cost into account.”

But Frederick knew that, before the salesperson intervened, he hadn’t done that analysis. Suspecting that other consumers were likely to fall into the same trap, he and his colleagues designed a study to test whether consumers spontaneously considered opportunity costs.

One of the questions in their study was this:

Imagine that you have been saving some extra money on the side to make some purchases, and on your most recent visit to the video store you come across a special sale on a new video. This video is one with your favorite actor or actress, and your favorite type of movie (such as a comedy, drama, thriller, etc.). This particular video that you are considering is one you have been thinking about buying for a long time. It is available for a special sale price of $14.99.

What would you do in this situation? Please circle one of the options below.

(A) Buy this entertaining video.

(B) Not buy this entertaining video.

Given this choice, 75% bought the video and only 25% passed. Probably you’d have made the same decision—after all, it’s your favorite actor (Leonardo DiCaprio!) in your favorite type of film (sinking-ship movies!) and you’ve been considering it for a while.

Later the researchers asked a different group of people the same question, but with a minor modification (printed here in bold):

(A) Buy this entertaining video.

(B) Not buy this entertaining video. Keep the $14.99 for other purchases.

Surely the part in bold should not have to be stated. It’s obvious and even a little insulting. Do we really need to remind people that they can use their money to buy things other than videos?

Nonetheless, when shown that simple, stupid reminder, 45% of the people decided not to buy the video. The reminder almost doubled the chance that people would pass on the purchase! Which makes us wonder whether Quaker, when considering its Snapple acquisition, would have benefited from a slight tweak to its choices:

(A) Buy Snapple.

(B) Don’t buy Snapple. Keep the $1.8 billion for other purchases.

This study presents very good news for all of us. It suggests that being exposed to even a weak hint of another alternative—you could buy something else with this money if you want—can change our purchasing decisions.[‡]

We can understand if you’re a little suspicious that our decisions can be improved so easily. It’s rarely so simple to “repair” one of our cognitive biases. It’s like learning that you can cure the avian flu by clapping your hands.

But here’s the catch: You won’t clap your hands if you don’t realize you have the avian flu. Or to escape that metaphor: You won’t think up additional alternatives if you aren’t aware you’re neglecting them. Often you simply won’t recognize you’re stuck in a narrow frame.

Think about Frederick’s predicament. What’s in his spotlight? The two stereos. He stares at them, mentally comparing their aesthetics and features and prices. It’s a hard comparison; how much is it worth to have a wider frequency range? Or a slightly cooler speaker design? As he dwells on what’s inside the spotlight, his brain obligingly ignores what’s outside, like the music he could buy if he picked the cheaper stereo. In a sense, he was the victim of his own ability to focus.

Focusing is great for analyzing alternatives but terrible for spotting them. Think about the visual analogy—when we focus we sacrifice peripheral vision. And there’s no natural corrective for this; life won’t interrupt our focus to draw our attention to all of our options.

Frederick’s stereo salesperson was surprisingly good-hearted to break his focus and prompt him to think about opportunity cost. A more mercenary salesperson, who wanted to maximize her commission, would never have gone there. She’d have kept Frederick’s spotlight trained on the expensive stereo: “You know, Shane, it’s ultimately a matter of quality. Do you think it’s worth paying a little more to hear your favorite bands more clearly?” (You will never encounter a car salesman who says, “Hey, why not buy the entry-level model and use the savings to take your family on vacation?”)

Our lack of attention to opportunity costs is so common, in fact, that it can be shocking when someone acknowledges them. Frederick and his coauthors highlight a speech from Republican president (and former general) Dwight D. Eisenhower in 1953, a few months after he took office in his first term: “The cost of one modern heavy bomber is this: a modern brick school in more than 30 cities. It is two electric power plants each serving a town of 60,000 people. It is two fine, fully equipped hospitals. It is some 50 miles of concrete highway. We pay for a single fighter with a half million bushels of wheat. We pay for a single destroyer with new homes that could have housed more than 8,000 people.”

How much better would our decisions be if more people shared Eisenhower’s willingness to consider opportunity costs? What if we started every decision by asking some simple questions: What are we giving up by making this choice? What else could we do with the same time and money?