Issue 41
Year 2
2007-10-09

Tri 4.49 (+0.89%) Pye 8.66 (+2.12%) Mex 43.48 (+3.91%) Iso 101.58 (+4.91%) Noc 581.75 (+6.05%) Zyd 390.85 (-7.62%) Meg 814.08 (+3.63%) Mor 5,060.47 (-1.25%)
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Opportunity Cost

It’s amazing how many people have no idea what Opportunity Cost is, and it worries me how few of those who have heard of it actually understand it. There are people out there who are manufacturing and building modules and ships and they are actually losing themselves money by doing it!

I don’t mind peoples’ idiocy costing them money except that I am competing with them. When they drive down the prices to loss-making extremes then that hurts all those industrialists who do know what they are doing as well as those who don’t.

I had a bit of an internal debate when it came to writing this article, should I do it as a rant pointing out how stupid people are? Do it as an informative guide? Step by step explanation?

Hopefully I’m going to strike a happy medium, if it descends into a rant though then don’t take it personally! I promise not to call you an idiot just because you had never realised this. Of course if you refuse to read this article or read it then keep going anyway then I, along with everyone else, will call you out for being the moron you are.

I will start with an example, which hopefully will explain what I mean by opportunity cost.

Example: The miner industrialist.

The miner goes out and mines all the low end ore needed to build a cruiser, he refines the ore, buys a BPC, builds the cruiser and sells it on the market.

Now, this is a valid set of steps to take and could potentially increase your profit on the ore, but let’s take this step by step and see what happens.

For this purpose I am going to invent a mythical cruiser just to keep the maths simple, let’s call it a Fred. It needs 1000 Zydrine and 1 million Tritanium to build.

The miner goes out and mines Veldspar until he has 1 million units of Tritanium. He then buys 1000 units of Zydrine at a cost of 1.5million Isk.

When he looks at the market he sees a buy order for Freds at 3 million Isk. Bargain! He sells the Fred and makes 1.5million Isk. Profit! Result!

NO NO NO NO NO NO NO NO NO WRONG WRONG WRONG!!!!!

He didn’t just make 1.5million Isk profit, he just made a 1.5 million Isk loss. Let me repeat for those people out there mining and building ships that are doing this, as I doubt you followed me the first time. He is making a loss.

Let’s have a conversation with our little industrialist:

“Why are you selling that Fred at a loss?”

“Oh I’m not, I’m making 1.5 million Isk profit!”

“How are you making 1.5 million Isk by selling at 1.5 million below build cost?”

“Well I mine all the Tritanium myself, so it is free.”

No, no, no, no, no, no, no, no, no, no, no. Wrong, wrong, wrong!

It is not free. It has an opportunity cost.

How much could you have made by selling that Tritanium on the open market? At current prices, 3 million Isk. So let’s run through this again properly:

Step 1:
Mine for a while: Make 3 million Isk worth of ore.
Excellent, 3 million profit.

Step 2:
Buy Zydrine and BPC: Lose 1.5 million Isk.
Fair enough, you need to invest to make money.
Use Zydrine and Tritanium to build one Fred
Investment so far 4.5 million Isk.
Sell 1 Fred for 3 million Isk.
Congratulations you just lost 1.5 million Isk and turned a 3 million Isk overall profit into a 1.5 million one.

In this example he actually had 3 million Isk at the end of Step 1; he then spent 1.5 million Isk extra and ended up right back where he started. In other words he had a 3 million Isk profit at the end of step 1 and then reduced that to a 1.5 million profit at the end of step 2!

Here is another example – invention and data cores. How many inventors out there are not including the data cores they get from their agents in their invention costs?

Come on, own up – I know you are out there as I have talked to some of you!

Yes you get them for free, but they still have value. You could sell them on the market and skip the whole inventing step and still make money.

The important lesson here is when you are using multiple linked steps as part of a chain then check that every link in that chain is making you Isk and adding value. If it isn’t then don’t do it.

For example:

Mine 3 mill Tritanium
Excellent, 3 million profit
Build 1 Fred using 4.5 million Isk
Unless you can sell it for substantially more than 4.5 million Isk then it isn’t worth it.

In this example both steps need to independently increasing your profit. If you find you can buy the minerals more easily than mine them then do that. If you find that you cannot build Freds and increase your profit then just sell the minerals. Every single step in the chain should be evaluated and if it doesn’t make money (or worse, loses money) then don’t do it.

An invention example:

You take 16 mechanical engineering and 16 starship engineering datacores along with 10 million Isk in other materials and use them to run an invention job.

You got those datacores from research agents, so the cost of the invention job was 10 million Isk right? Right? Right?

No, of course it isn’t. I’m sure you see where I am going here. Break down the stages and you can see:

Stage 1: Research agent gives me 32 datacores worth 24 million Isk.

Stage 2: Use 32 datacores + 10 million to perform invention

Your invention cost is 34 million Isk as even though you never turned those datacores into Isk you could have done. There was an opportunity to sell those datacores and make 24 million Isk so you have cost yourself that opportunity.

So how to avoid the cost trap?

I already touched on this a little but you need to break down the process into a series of steps.

Miner Industrialist:
  1. Mine
  2. Refine
  3. Build
Inventor:
  1. Get datacores
  2. Invent
  3. Build
Can you buy the minerals more cheaply than mine them? Can you sell the minerals for more than you can sell the built product? Is it worth refining my ore myself or can I sell the ore for more than the refined minerals? It is frequently the case with low refining skills and standing that you are better off selling the ore.

Can I sell the datacores for more than the worth of the invented BPC? Can I sell the invented BPC for more than I can make building the end product?

These are all questions you need to be asking yourself, and unless you are getting a good increase in profits from each step then don’t do that step. A simple rule of thumb for every step in the chain is “if I wasn’t doing the rest of the chain would it still be worth me doing just this step”. Also evaluate the time and resources you spend on each step. If you spend 3 hours managing your industrial side then it had better make you more Isk than you can make in 3 hours mining.

Nothing stops you mining the Veldspar, selling it as Ore and then buying refined minerals off the market using buy orders. If that makes more money for you than doing the whole process then do that.

Of course some people do decide to mine themselves into a ship, I even know someone who mined themselves the minerals for a ship, bought the BPC and built the ship. He then invented all of the tech 2 modules to fit it and built those two. That was a fun target he set himself, and is a perfectly valid way to play the game, but he was also well aware that he was doing it for fun and satisfaction. It would actually have been cheaper just to buy everything off the market!

Another valid reason to take a loss in one area is where you have a long supply chain and you do a step in the chain that actually makes no profit or even a small loss simply to ensure that the whole chain is under your control. Sometimes it is worth doing that but the important thing is to be aware of it and to have planned for it. Work out the cost of what you are doing and only do it if the benefits outweigh the cost.

Now go out there and make some Isk, and next time you hear someone say “but I mined the ore myself so it’s free” then give them a smack them around the back of the head from me and send them to read this article.

Zarch AlDain



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