Every single day, you have to make choices in your pharmacy — choices that cost you. Every time you make a choice and reap the benefits that come along with it, you forego the benefits of the choice that you don’t make.
That trade-off is known as an opportunity cost. While you can never really know how life would have turned out if you’d made the other decision, you can make an educated guess.
By assigning a specific dollar amount to your choices in the pharmacy, you can make a more informed decision than if you simply used a pro-and-con list.
To make financially savvy decisions about your independent pharmacy’s business, learn how to calculate opportunity costs and when to apply those calculations.
How to calculate an opportunity cost
Like most pharmacy metrics, opportunity cost can be calculated using a simple formula:
Opportunity Cost = Estimated return on option not chosen – estimated return on chosen option
If your opportunity cost is positive, that’s money that you forego by choosing the option with a lower estimated return. If it’s negative, that’s money you gained that you wouldn’t have if you’d chosen the other option.
Let’s say you have a chunk of money to invest in your pharmacy. Your first investment option is to renovate your pharmacy, which could potentially bring in an additional profit of $5,000 a month. Your second option is to purchase pharmacy automation equipment, which could increase profit by $10,000 a month.
You choose to renovate your pharmacy. You’d calculate the opportunity cost of that decision like this:
$10,000 (Return on pharmacy automation) – $5,000 (Return on renovation) = $5,000 (Opportunity cost)
Renovating your pharmacy isn’t necessarily a bad investment — you’re still bringing in an additional $5,000 that you wouldn’t have made if you hadn’t renovated — but by calculating the opportunity cost, you can see that you could have made an even better investment decision.
By choosing to renovate your pharmacy instead of investing in automation equipment, you’re missing out on an additional $5,000 you could have brought in every month with automation.
You can also use an opportunity cost to assess your past choices. If you made the decision to start offering a flavoring service last year, you can compare the actual return on investment to the return on investment for another service you were considering, like diabetes education.
If your flavoring service had a 10 percent return on investment and you think a diabetes education program would have had a 5 percent return on investment, you can use that information to calculate the opportunity cost.
5 percent (Diabetes education) – 10 percent (Flavoring service) = -5 percent (Opportunity cost)
In this case, since the opportunity cost was negative, you can know that you made a better financial decision by investing in a flavoring service. If you had invested in diabetes education instead, you would have lost out on an additional return of 5 percent.
Opportunity costs and sunk costs
Opportunity costs go hand-in-hand with another type of business cost: the sunk cost.
While the opportunity cost is the cost of not taking an opportunity, a sunk cost is the cost of taking an opportunity. It’s the money you spend to pursue one opportunity over another.
Let’s go back to our first example: when you chose to renovate your pharmacy rather than purchasing a robot for your pharmacy, you incurred an opportunity cost of $5,000.
But you spent money on that renovation, too — say, $30,000. That’s money that went to accomplish a concrete goal and won’t be able to get back. You may be able to make a profit to cover that cost, but you won’t be able to get that specific $30,000 back.
Since sunk costs deal with hard cash and opportunity costs don’t actually affect your pharmacy’s cash flow, some business owners may give more weight to the sunk costs than the opportunity costs.
You should still consider opportunity costs over sunk costs when making a decision. If, after you’ve done your interior remodel, you have a choice between remodeling the exterior of your pharmacy or purchasing pharmacy robotics, it might be tempting to say, “Well, we’ve already spent all this money on the interior remodel, so we might as well continue with the exterior remodel.”
But doing this succumbs to the sunk cost fallacy. Instead, you should forget the money you’ve already spent and look at the potential opportunity costs.
If robotics will bring you a better return than remodeling your exterior, that’s still the better decision — even if you have already spent money on the interior remodel.
The limitations of calculating opportunity costs
As a decision-making tool, looking at opportunity costs is a useful way to assess your choices from a financial point of view. But it’s not a perfect predictor of which choice will be more successful.
The main limitation is that calculating opportunity costs requires you to make your own predictions about each opportunity’s future financial return.
For each choice, you can do a lot of research and come up with a close estimate. You can stay up to date with industry sources, ask fellow independent pharmacists about their experiences, and talk to vendors to find out how a particular service could affect your pharmacy’s profits.
But your estimate won’t be perfect, and wishful thinking can sway your assessment.
Sometimes, even with well-researched analysis, the future throws you for a loop. An analysis of opportunity costs may have shown that starting up a pet meds business would have a better return than expanding your compounding abilities — and then a global pandemic hits and creates a huge need for compounded hand sanitizer.
Ultimately, things will always play out a little differently than your opportunity cost calculations predicted.
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PBA Health is dedicated to helping independent pharmacies reach their full potential on the buy-side of their business. Founded and run by pharmacists, PBA Health serves independent pharmacies with group purchasing services, wholesaler contract negotiations, proprietary purchasing tools, and more.
An HDA member, PBA Health operates its own NABP-accredited warehouse with more than 6,000 SKUs, including brands, generics, narcotics CII-CV, cold-storage products, and over-the-counter (OTC) products — offering the lowest prices in the secondary market.