Every Business Decision Has a Hidden Price — Here's How to Calculate It
How i almost rejected software
The School of Knowledge is the weekly newsletter for SME owners and investors who want frameworks they can actually use — frameworks, checklists, and operating manuals every weekend, built to read on Sunday and use on Monday.
Every capital allocation decision you make means foregoing other options available to you—and getting those decisions right is the difference between good investments and great ones.
Between a 12% return or 20%.
Great investors such as Charlie Munger and Nick Sleep thought about capital allocation a lot, and i leaned on their way of thinking when i had to make a capital allocation decision for my business this week.
The construction industry is cyclical. We’re usually one of the first industries impacted by recessions and usually the last out of one. The last couple of years i’ve seen clients delay more projects, material and labour prices double and national insurance rates shoot up, all contributing to a difficult period for the industry.
But, a declining industry offers opportunities for businesses that operate well, have healthy margins and, more importantly—have cash on their balance sheet ready to deploy.
Being a Principal Contractor in the UK, you are heavily reliant on being competitive enough to win jobs through the public or private sector, which in general is just a race to the bottom with margins amongst the lowest in any industry. A big part of this is the layers upon layers of bureaucracy in the industry—all taking their fees whilst passing on the risk to the contractors. Fair enough—but i want more reward for my risk.
A couple of weeks ago i was presented with software that cut right through those layers of bureaucracy and went straight to the source of what we wanted to do as a company: buy land, build commercial buildings on it, and then sell or rent them. No estate agents to deal with, no developers, no consultants—no waiting around for people to do things for you. No tendering. A direct link to the landowner, with a service that even sent them letters with your offer.
It was great, but the problem was that the software was expensive and i declined their service. But, a few days later i sat and thought about the decision i’d made. With this software i could do everything remotely. i didn’t even need to leave my desk. By rejecting their service i was accepting that i was willing to carry on searching for land the old way; scrolling websites, communicating with estate agents, taking time out of my day to go and view the land, and relying on them to get back to me whenever they pleased. Not to mention the synthesised bidding wars they create.
i added up the time it would take for myself or my business partners to do all of this, and conservatively estimated that the minimum would be two days a week if we were limiting our search to the North West of England, and were taking it half-seriously. We are also unquestionably up against other companies who have whole departments dedicated to doing something similar, with better resources and more capital.
Once i looked at the maths—the cost of one of us doing this manually for two days a week, or 104 days a year (not accounting for holidays)—it dwarfed the annual cost of the software. That’s before any savings from going direct to the vendor and developing and building ourselves.
The opportunity cost of not purchasing the software was too high, so i made a call with my tail between my legs and changed course (not before getting two months free).
i don’t have a crystal ball and time will tell if the investment pays off, but by understanding the concept of opportunity cost—by being able to work out the present value of future cash flows—i’ve given myself a reasonable edge and sought to take back more control over my company’s future prospects.
And that’s what The School of Knowledge hopes to assist you with. Making better business and investment decisions. There are no rose-tinted glasses here—i call a spade a spade and look to share everything i’ve found useful in getting to where i am today.
If you’re an operator—someone who does things—and would like to read more about capital allocation, opportunity cost and net present value, click through to the following posts:
For paid subscribers, next Saturday i produce a deep dive into the most paralysing form of business strategy: Counter-Positioning. To read the first two articles in this series click below.
Until next time,
Karl.