Lionel Robbins, a distinguished professor gave the definition of Economics as:

Economics is the study of the use of scarce resources which have alternate uses

In simpler words, economics is the study of opportunity costs. That is, if you choose A you are foregoing the joy of B. If you choose B, you are foregoing the joy of A. Therefore the real cost of A is the foregone joy of B. And the real cost of B is the foregone joy of A.

For example, I am spending two hours thinking, writing and rewriting this blog. I could have spent these two hours, say reading a book. Therefore, by choosing to write this blog, I am foregoing the benefit of reading a book. Whether, I like it or not, it’s an opportunity that I am foregoing. So, I better make sure, that I get more of this blog than the foregone reading.

Now, here is another manifestation of opportunity costs. Just because you are good at anything, should you do everything?

Say, there is this guy who is studying to become to an eye surgeon. And, in order to pay for his college expenses, he washes a lot of cars. And since he washes a lot of cars, he has gotten really good at it.

And let’s say that after a few years, he finally becomes an eye surgeon. Should he now wash his own car or let someone else do it, even though he could wash it much better than the other guy? Think about it- he is good at eye surgery and washing cars. Does that mean he should do both?

No, no, of course not! He has a limited amount of time everyday and therefore he should perform as many eye surgeries as he can and let someone else wash his car. That is the best way for him to add most value to himself and the society. If he washes his own car, he is foregoing an eye surgery which would be more valuable to him and society. On ther other hand, if he performs an eye surgery he foregoes a washed car, but that is less valuable. And therefore, he should focus on eye surgeries and let someone else wash his car.

To repeat the question: just because you are good at anything should you do everything? No. There are opportunity costs and therefore we must pick the activity that best adds value to ourselves and the society.

Likewise, just because the lion can hunt any animal, should it hunt a mouse? No, because it’s going to need tens or hundreds of mice to make a meal. It’d rather wait longer and go after a larger animal. That is what the lion is built for.

Let’s try and apply this metaphor of eye surgeon and car washing.

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HDFC Bank is India’s top private bank. It borrows money from the RBI, from the public via Fixed Deposits and from the general market. It then lends this money to borrowers who want to buy houses, vehicles or to invest it in their business. It’s average cost of borrowing is about 5% and it’s lends it out at an average of about 9%.

Manappuram is a non bank finance company and it’s primarily lends against gold. It borrows money from banks like HDFC Bank and from other corporates at an average of 10%. It then lends this money to borrowers at an average of 24%.

Think about it: isn’t HDFC Bank a big fool to lend at 9%, while Manappuram which borrows from banks in turn lends at 24%? HDFC Bank, should forget everything else and get into gold loans right?

I had the same thoughts a few years ago. To answer this conundrum, let’s rephrase the question as: just because HDFC Bank can get into any lending business, should it get into every lending business?

Consider this:

• HDFC Bank has a loan book of close to Rs 11 lakh Crs. Manappuram has a loan book of Rs 2500 Crs.
• HDFC Bank earned a profit of 27,000 Crs in FY 20. Manappuram earned a profit of 1461 Crs.
• HDFC Bank’s average loan size is several lakhs. Manappuram’s average loan size is about Rs 50,000
• HDFC Bank’s market cap is Rs 5.74 lakh Crores. Manappuram’s market cap is Rs 13,000 Crs. In short, the market values one HDFC Bank same as 44 Manappurams!

The HDFC Bank engine is built to lend large sums of money, efficiently and profitably. The Manappuram engine is built to lend very small sums of money efficiently and profitably. If HDFC Bank tries to do what Manappuram is doing, it may lose efficiency or profitability or both.

Therefore, gold lending even though super profitable is an opportunity that HDFC Bank should forego, because HDFC Bank can go after bigger and better opportunities. It’s that simple!

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Yet, you would be surprised how many times executives forget simple ideas and succumb to envy. For example, large corporates with no experience in the aviation industry start an airline when the oil prices are low. Or get into the retail business looking at how profitable other retailers are. And time after time, they are handed a brutal lesson that just because they can deploy their money in any opportunity doesn’t mean they should go after every opportunity!

Thanks for reading!

(I picked the eye surgeon and car washing example from the book “Basic Economics” by Professor Thomas Sowell. I understood opportunity costs much better than ever, with that example. This is probably the best book I have read in my life. I highly recommend this book. )