URSABLOG: Sunken Opportunities

Our lives are full of choices where we have the opportunity to gain something, but at the loss of something else. Opportunity cost, defined as ‘the loss of other alternatives when one alternative is chosen’, is everywhere. My former boss used to say “never leave a lunch early, you never know where it’s going to lead” and lived by it, but for me staying later and later at lunch not only wiped out the rest of the afternoon’s work, but a good slice of the next day’s too. Mind you he had a better head (and stomach) for drink than I do, and the stellar amount of business he has done in a long and successful shipbroking career suggests he made the right choice for him. I suspect if I had followed his advice I would ended up in rehab.

So how can we make the right choices? When I am teaching my Institute of Chartered Shipbrokers students on the concept of opportunity cost, I usually use two examples. The first is deciding whether to use a piece of land to grow vines for wine production, or to plant olive trees to make oil. The vines will only start producing half decent wine after about three or four years, and then it will take the same again, tweaking, adjusting and innovating until you get a product that you are happy with. And then many more before you get the consistency of production that the market will reward you with, if you are lucky.

Olive trees however take a lot longer to mature and bear fruit, and whilst producing oil is more simple a process after the harvest, but only then will you know if the yield is sufficient enough to give you a return on your investment. By then – in both cases – time has passed and it is too late to rip out the vines or uproot the trees and start again. And markets of course play a great part too. Interest in wine has peaked (believe me you can only drink so much wine) and the market is oversupplied. However olive oil prices keep rising as droughts, pests and disease affect the yields. Making the choice is risking the unknown, and the future may reward you. Or bankrupt you.

The second example is a little more accessible to the students. Exam time is approaching and you know you must study, especially as your company – who is paying for your studies – will be less than overjoyed if you fail. However you have been invited away on a weekend in a villa on a fashionable island where not only is the company agreeable, but a long term object of romantic interest will be there, having just got over a painful break-up. What to do?

You can take the ‘sensible’ choice, decline the invitation and study hard and diligently, but due to a lack of inspiration and a misunderstanding of a question you fail by two marks. In the meantime you hear that your object of romantic interest was disappointed in your absence and decided – perhaps in spite – to hook up with someone else and this relationship is now going strong.

Or you can decide to throw caution to the wind and go, have a great time, and in the process get closer to the potential paramour. You find to your surprise that not only does the first stages of a love affair give you more energy and desire, so you have the confidence to overcome any challenges in your way, but also that your new companion not only wants you to succeed, and encourages you to work, but as a former student gives you all their notes and you spend many (although not too many – time is short) evenings and weekends studying together – interspersed with other nice things that happen in the first stages of a love affair – so that when you get to the exam you pass with flying colours and everyone is happy for you, and happy with you. And you and your partner are setting off on a happy life together.

The point of opportunity cost is it always comes with a risk. Any decision does. And although the second example may have within it the risk of encouraging my students to go out and party rather than study, it also shows again, that the risk is subject to, well, future market conditions.

In shipping, opportunity costs are everywhere. Deciding to buy expensive secondhand ships in the hope of an imminently booming market as opposed to ordering less expensive (but still expensive) newbuildings to have newer ships in the future. Or fixing a ship on period charter because the short-term freight market is lukewarm. The choice depends on your risk appetite and your ability to forgo future gains for medium term security. But it may also lead you to seethe with jealousy when the spot market pops and your charterer is taking advantage of it. Or maybe you will be proved right. My point, again, is that every decision carries a risk of surprise – on the upside or the downside – but once you have made that decision you are stuck with the consequences. And the consequences are rarely in your hands.

And this is where stubbornness, or even doubling down on the risk, takes place, usually because you want to be proved right. The tactical decision to trade period may – you may say to yourself – have been wrong in this case, but the strategy was correct. So you fix on period again. Or you missed the boom in the freight market that your newbuildings with later deliveries could not take advantage of, so you order more ships that have since become cheaper anyway. Welcome to the world of sunk costs.

A sunk cost is an expense that cannot be recovered by additional spending or investment. Ordering more newbuildings because the original orders did not live up to the investment does nothing to make the original orders a better idea. Continuing to fix on period because you cannot admit to yourself that the original idea didn’t work out does not bring the lost freight back. We are sensitive creatures, and many times we cannot admit to ourselves that we were wrong, but the cost of wanting to be proved right can be greater than losses resulting from the original decision.

This shows up in personnel decisions. You may employ someone who ticks all the boxes on their CV but when they start working for you, you realise pretty quickly that they are tragically temperamentally unsuitable for the job. But still you keep going, trying different things, different ways to prove yourself right and that things are going to change, and yet they don’t. This is usually accompanied by a stubborn feeling that “well I’ve invested so much time, money and effort in this person that I’m damned if I don’t get back that investment.” You can substitute the word ‘person’ in that sentence with ‘project’, ‘investment’ or ‘strategy’.

In our personal lives too, we are prone to this. We have invested so much in a relationship, in a person (romantic or otherwise), or in a project, in an idea or ideology (or even a way of thinking) that we are damned if we’re going to give up now. We don’t like finding out that our original decision or choice was wrong, even though it’s no-one’s fault necessarily; but refusing to accept it has turned out wrong only increases the unhappiness, frustration and hopelessness of the situation. But we should, as business studies books advise, be careful to exclude sunk costs from future decisions because they will remain the same regardless of the outcome of those decisions. The realisation that we’re not going to get anything out of our investment is a hard one to stomach, and the bitterness of a breakup, or sacking, or divestment only increases when the inevitable decision is inevitably postponed. Hope may die last, but once it’s dead, it’s subsequent absence can be even harder to accept.

The two concepts of opportunity cost and sunk costs are of course related. Every decision comes with a price attached, in money, time, emotion, in peace of mind. Even in love. And once that decision has been proved wrong, or at least inappropriate, the gnawing suspicion that further investment – of money, time, emotion, of peace of mind, or even love – will not improve the situation, however much we would like it to, should be listened to, examined and analysed, and acted upon. Which may be a risk in itself, and go against the idea of who we are, but when that decision is placed in our hands we have to take responsibility for it, because not acting will only make the situation worse. Which opens a big door to a discussion on procrastination, which is better left shut at this time (maybe because I don’t think I’m ready to open it quite yet).

There is a Spanish proverb, which I like, which says “God says take what you like. And pay for it.” But paying for it once doesn’t mean you have to keep paying for it over and over again. We all have a responsibility to invest in our own success, happiness and peace of mind. And whilst we all can – and should – make the wrong decisions from time to time our responsibility is to recognise them and learn from them, so as not to repeat them, or worse, double down on them, in the hope of a different outcome. That would be – if not madness – but at the very least losing an opportunity to rise up again and have the chance to make newer decisions in the future. I suspect that increasing the number of decisions I make, rather than delaying the inevitable, will make me better at making them. It’s a risk worth taking.

Simon Ward