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Math for Arts Administrators: Opportunity Cost

Part I: Knowing all the costs of a particular choice will help make you make your next smart decision

While arts administrators have little use for algebraic or trigonometric functions, there are other more strategic uses of mathematical and economic principles that can guide future decisions. This first installment of the series examines opportunity cost.

Opportunity Cost: "The loss of potential gain from other alternatives when one alternative is chosen." As a more concrete explanation, review the seven doors pictured above. If you can only walk through one (make one decision) then you "lose" the opportunity to open the remaining six doors.

As an example of this, say you're a nonprofit theater considering adopting a new technology such as a CRM, technical automation software, or website. You likely have a current solution, and you have calculated the "switching cost" of staying with your current solution is greater than that of adopting a new one. Awesome--you're well on your way to advanced calculus in the arts!

Measuring this switching cost results in a variety of choices you must make. In other words, the switching cost brought you into that room pictured above, but now you have to choose what door through which to walk: if you select system X it has various features but will require staff training; if you select system Y, it lacks some desirable bells/whistles but is lower out-of-pocket costs and perhaps will allow you to attract employees familiar with that software and not requiring training; system Z requires a large out of pocket cost and longer contract but the entirety of the costs are built into the agreement... you get the idea.

Opportunity costs remain largely uncalculated in nonprofit arts administration for a few reasons:

1. Under-resourced departments and individuals narrow their selections too quickly. Alternatives are immediately dismissed as too costly in out-of-pocket costs, time, risk to personal job security, inertia, etc.

Imagine a marketing director tasked with building an advertising plan for a particular event. The prior dozen campaigns performed well but at diminishing returns on particular campaign assets. Redirecting a significant portion of those limited advertising dollars through a new (and possibly costly) advertising channel might result in greater return on investment. But it also risks failure and that director will be criticized for not, "doing what worked before."

2. Opportunity cost is not the same as a true out-of-pocket expense. And in an environment where such expenses are, rightfully so, watched closely, the true expense overrides thoughtful examination of opportunity costs.

Imagine a technical director tasked with selecting new project management software but told the ultimate selection must be the cheapest--even if it means designers and technicians working on the project must spend more of their paid hourly time working around some of the selected solution's deficiencies. Ultimately that "cheaper" solution is more expensive, but it lands in a different line (payroll/HR) and thus the true cost is obscured.

3. Time and workflow constraints: individuals, committees, and boards feel pressured to make a decision quickly so they rely on anecdotes, referrals, and other "soft" influences far more than a comprehensive--even if rather roughly estimated--survey of the costs of a particular decision.

Imagine an executive director tasked with selecting a new ticketing/donation/CRM solution. Well-intentioned but uninformed board members (who may also sit on neighboring arts organization boards) share that a particular solution works for another organization--never mind if that company has vastly different needs and infrastructure--and offer a strong recommendation (hint hint, nudge nudge).

In addition to a "top down" example, this phenomenon occurs from the "bottom up" where a qualified job applicant for an important marketing or fundraising position would require an entire organization to change software solutions to one with which they are accustomed. In this example, not only are the costs of the individual employee's compensation to be calculated, but also the cost of the new software, staff re-training, etc. Given the length and costs of some software contracts, rate of employee turnover, and other factors, this seemingly small six-figure decision could balloon into a seven-figure costs to the organization over the life of the software agreement.

So what is an administrator to do?

1. Raise the concept of opportunity costs in your regular meetings. This will begin the inoculation process to allow employees to make calculated choices.

2. Track and eventually append "soft" expenses like staff time into your reports/projections. Finance officers have an obligation to track expenses in certain categories and using certain methods, but budgets tell a story and arts administrators have a fiduciary responsibility to tell that whole story.

3. Offer clarity in your decision-making process. If indeed you are taking one opportunity over another mostly due to a staff or board recommendation, communicate that to other stakeholders. Time is valuable and referrals are an excellent way to keep staff focused on other priorities, but being transparent about such shortcuts might reveal when they are, and are not, appropriate.

Check future posts for write-ups on the Pareto principle (AKA 80/20 rule) and how basic statistic principles--despite what we all thought in high school--really can help "in real life."

As most arts administrators with whom I am familiar seem well versed in calculating "switching costs," I don't plan to write a whole post on that. Still, I can't help but share this video... sometimes the best of us can miscalculate switching costs.

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