Opportunity Cost
This concept will be useful throughout the AS-Level and A-Level Business Studies course.
It is at the heart of every business decision, from small to multinational companies.
Opportunity cost refers to the next most desirable alternative that must be foregone
when a decision is made concerning the use of scarce resources.
It can be explained with reference to football club management. In 2007, new manager
Lawrie Sanchez was given a budget of £25m to buy new players for Fulham FC. In theory,
he could have spent it on Owen Hargreaves (£17m) plus had enough left for the left leg of
Carlos Tevez. Instead, he spent it on nine players, largely from lower leagues or from
Premiership reserve sides. The cost of these players was £25m. The opportunity cost was
missing out on Owen Hargreaves and part of Tevez. The £25m could only be spent once,
so it was vital to spend it wisely. The sacking of Sanchez in December 2007 implied that
Hargreaves and Tevez might have been a better use of the club’s money!
Every business faces the same issue – limited resources mean that hiring a marketing
manager leaves less money to spend on a marketing campaign. For a start-up business,
lots of money spent on a flash opening party means less money to pay for staff training.
For a new business, the two most important resources are time and money. Both have an
opportunity cost. Time spent by an entrepreneur creating a pretty website might mean too
little time recruiting and training staff, or too little time sitting back to reflect on priorities.
The same issue arises with money; it can only be spent once.
It follows that every business decision has an opportunity cost, measured in time, money
and often both. The same is true in other walks of life. A prime minister focused on foreign
issues might lose sight of the key issues affecting people in the UK. A chancellor who
spends an extra £10bn on education may have to cut back spending on the NHS.
For a new business start-up, the most important opportunity cost issues are as
follows :
Market Research
Market research is basically the voice of the consumer. It involves gathering and analysing
data from the marketplace (ie from consumers and potential consumers) in order to
provide goods and services that meet their needs.
Start-up market research
Where do you start? What do you need to know first? And how do you find it out?
The starting point is to discover the marketing fundamentals: how big is the market you
are thinking about (market size)? What is its future potential? And what are the market
shares of the existing companies and brands?
Market size means the value of the sales made annually by all the firms within the market.
For example, in 2007 the UK yoghurt market was worth £1350m. Market potential can be
measured by the annual rate of growth. In the case of yoghurt, this has been at a rate of
4% per year. This implies that, by 2010, the potential market size will be over £1550m.
When looking at a completely new market, these statistics will not be available. So
research may be needed into other indicators. For example, the producer of a new
innovative fishing rod would find out the number of people who regularly go fishing.
Market shares are also of crucial importance when investigating a market, as they indicate
the relative strength of the firms within the market. For example, in 2007 27% of the UK
yoghurt market was held by Muller, making it the leading brand by far. A benefit it received
for its strong market share was a distribution level of almost 100% (in other words, nearly
every grocery store stocked Muller yoghurts). If one firm dominates a market, then it may
be very difficult to break into the market.
So how can firms find out this type of information? The starting point is carrying out
MARKET RESEARCH. There are two main types of such research – primary research
and secondary research. Primary market research (often called field research) refers to
data that is collected specifically for the purposes of the business. Secondary market
research (often called desk research) refers to data that already exists and was collected
at some previous time. Each type has its own benefits and drawbacks. Often the most
successful strategy is to combine some secondary research with a small amount of
carefully collected primary research. There is no perfect source of information or method
of collecting data, but overall, some data is better than none at all!
A business can research into a wide range of areas. For example :
Secondary Research
This is the collection of secondary data, which has previously been collected by others
and is not designed specifically for the study in question, but is nevertheless relevant. It is
sometimes referred to as desk research. Secondary data is far cheaper and quicker to
gather than primary data, but it can be out-of-date by the time that it is researched.
An existing business may have lots of useful data internally that it could use, such as sales
figures, stock records, geographical analysis of sales, financial records, reports from sales
staff about customer opinions, and even customer complaints! These can be very useful in
analysing the performance of the business. However, the entrepreneur attempting a
business start-up has no such data. There are many examples of sources of secondary
market research that an entrepreneur might use for a small business start-up. These
include :
1) The internet.
2) Trade press.
3) Government produced data.
4) Phonebook, Thomson Local, Yellow Pages.
5) Enterprise Agencies.
6) Business Link.
7) Previously carried out surveys.
8) Competition.
If the entrepreneur is willing and able to spend some money purchasing secondary
research, there are companies that specialise in collecting and analysing market
information. Some well-known ones include Mintel (www.mintel.com) and Verdict
(www.verdict.co.uk). These tend to be quite expensive, although they are detailed, so will
tend only to be used by established businesses or entrepreneurs with money to spare
(perhaps those that have a business angel investing in their business).
Primary Research
If an entrepreneur wants detailed, precise information about the market, it is often
necessary to collect it specifically for that purpose. This is primary market research data.
Business start-up entrepreneurs may not be able to afford to pay someone to collect
primary research, so may have to do it themselves. This is research designed to gather
primary data, that is, information which is obtained specifically for the study in question. It
is sometimes referred to as field research. It can be gathered in three main ways –
observation, questionnaires and experimentation.
involves watching people and monitoring and recording their
behaviour (eg television viewing patterns, cameras which monitor traffic flows, retail
audits which measure which brands of product consumers are purchasing, loyalty
card schemes, interactive websites).
are a means of direct contact with consumers and can take a
variety of forms. Personal questionnaires (such as door-to-door interviewing), postal
questionnaires, telephone questionnaires and group questionnaires (such as asking
for the attitudes of a group of consumers towards a new product). Questionnaires
can be a very expensive and time-consuming process and it can be very difficult to
eliminate the element of bias in the way that they are carried out. It is important that
every respondent must be asked the same questions in the same order, with no
help or emphasis being placed on certain questions / responses.
involves the introduction of a variety of marketing activities into
the marketplace and then measuring the effect of each of these on consumers. For
example, test marketing, where a new product is launched in a small, geographical
area and then the response of consumers towards it will dictate whether or not the
product is launched nationally.
The primary and the secondary research will provide the business with much data relating
to its markets and its consumers. This data can then be used to describe the current
situation in the marketplace, to try to predict what will happen in the future in the
marketplace, and to explain the trends that have occurred.
The table below illustrates the pros and cons of primary and secondary research :
Qualitative -v- Quantitative Research
Qualitative research attempts to gain an insight into the motivations that drive a consumer
to behave in a particular way. It is usually conducted through group discussions (often
called focus groups and involving groups of 6-8 consumers) in order to discover the
rationale behind consumers’ purchases. The group discussion is often chaired by a
psychologist in a relaxed manner, which should encourage the consumers to discuss their
shopping habits and pre-conceptions concerning certain products and brands. It tends to
give clues as to WHY consumers like or dislike particular products and brands. Qualitative
research can also be conducted through in-depth interviews between a psychologist and
a consumer. They have the same function as group discussions, but avoid the risk that
group opinion will be swayed by one influential person. This kind of data can be very
revealing and useful, but it is more difficult and expensive to collect.
Quantitative research involves carrying out market research by taking a sample of the
population and asking them pre-set questions via a questionnaire (normally 100+
respondents) in order to discover the likely levels of demand at different price levels,
estimated sales of a new product, and the ‘typical’ purchaser of the company’s products.
The data is numerical and can be analysed graphically and statistically. It is good for
establishing key information about a business and its market.
The table below illustrates the sort of questions that can be answered by quantitative and
qualitative research :
There are several types of sample that can be used to gather quantitative data :
sampling – this involves selecting people to ensure that everyone in
the population has an equal chance of being interviewed. If an interviewer goes to a
street corner one morning and asks passers-by for an interview, then the results will
be biased towards those who are not in work, those who perhaps do not own a car
and those who perhaps have time on their hands. As a result, the sample will not
be representative of the whole population. So achieving a truly random sample
requires careful thought. Research companies use the following method :
a) Pick names at random from the electoral register.
b) Send an interviewer to the address given in the register.
c) If the person is out, visit up to twice more before giving up (this maximises the
chances of catching those people who lead busy lives and are rarely at home).
This method is effective, but slow and expensive.
sampling – this method involves selecting interviewees in proportion to
the consumer profile within your target market. For example, consider the following
table referring to a survey into adult buyers of chocolate bars :
Chocolate buyers Respondent quota
(sample : 200 people)
Men 40%
Women 60%
16 – 24 years 38%
25 – 34 years 21%
35 – 44 years 16%
45+ years 25%
This method allows interviewers to head for busy street corners, interviewing whoever
comes along. As long as they end up achieving the correct quota, then they can interview
when and where they want to. As this is a relatively cheap and effective way of sampling,
it is the one used most commonly by market research companies.
sampling – this involves interviewing only those with a key
characteristic required for the sample. For example, the producers of Olay might
decide only to interview women aged 30 – 45, the potential buyers of the future.
Within this stratum/section of the population, individuals could be found at random
(hence stratified random sampling) or by setting quotas based on factors such as
social class and region.
Sample Size
Having decided which sampling method should be used, the next consideration is how
many interviews should be conducted : 10? 100? 1000? The most high-profile surveys
conducted in Britain are opinion polls (eg asking people how they will vote in the next
general election). These quota samples of between 1000 and 1500 respondents are
considered large enough to reflect the opinions of an electorate of 45 million!
If you only interviewed 10 people, the chances are slim that the views of this sample will
match those of the whole population. A sample of ten people is so small that chance
variations make the results meaningless. In other words, a researcher can have no
statistical confidence in the findings from a sample of ten people.
A sample of 100 is far more meaningful. It is not enough to feel confident about the
marginal decisions (eg if 53% like the red pack design and 47% like the blue one), but it is
quite enough if the result is clear-cut (eg 75% prefer one brand name, whilst 25% prefer
another). Many major product launches have proceeded following research on as low a
sample number as 100. With a sample of 1,000 people, a high level of confidence in the
results of the survey is possible. So why doesn’t everyone use samples of 1,000 people?
The answer is MONEY. Hiring a market research agency to undertake a survey of 100
people costs approx £10,000. A sample of 1,000 people would cost approx £30,000. Good
value if you can afford it, but not everyone can.
Writing a questionnaire
Quantitative research is expensive and its results may influence major decisions such as
whether to launch a new product. So a mistake in writing the questionnaire may prove very
costly. For instance, the wording may influence respondents to sound more positive about
a new product than they really feel. What are the key features of a good questionnaire?
Factors affecting choice of sampling methods
There are 4 main factors affecting the choice of sampling methods that a firm can use :
Available finance.
The nature of the product.
The level of risk.
The target market.
Market research today
Market research is increasingly influenced by technology. There are more and more
internet opinion polls and pop-up questionnaires appearing on the screen. For instance,
someone looking at the Amazon.com shopping site might be asked to answer questions
about book buying. An even stronger trend is towards database-driven research. Retailers
such as Tesco have millions of customer names on their databases, gained from
customers’ membership of loyalty card schemes (Tesco Clubcard). Shoppers are grouped
into categories such as regular/irregular shoppers, petrol buyers, disposable nappy
buyers, etc. If Tesco wants to survey customer satisfaction with its baby products section,
then it knows exactly who should be contacted.