At its most simple, opportunity cost represents the potential loss of what one did not choose. The law of diminishing returns, or in more colloquial terms, “if it ain’t broke, don’t fix it,” is the concept that adding to an already optimally functioning body ceteris paribus can result in minimal or even damaging gains. We have used Real Madrid’s original Galácticos era as an excellent case study for this in a particularly unique market.
In the early 2000s, the Spanish capital club bought various iconic players in a quest to secure both incredible results and incredible performances. This, however, came at a cost. When President Florentino Pérez bought international superstar David Beckham from Manchester United in 2003 for €37.5M* he cut costs elsewhere. Beckham came into a front five that was already established with stars. Claude Makélélé, eventual opportunity cost, who was an essential part of the back six and the team, but was also worried about his position and under appreciated by the president, asked for an improved contract. Pérez refused and sold him to Chelsea Football Club for €20M*. Beckham was a wholly unnecessary purchase as he was more of a “substitute good” for the players already present (such as Luís Figo, Guti and Zinedine Zidane) whereas Makélélé, a “complementary good”, was integral to the team’s success. Taking this into account, we observe the price of buying Beckham and selling Makélélé as part of the opportunity cost.
Opportunity cost is an ideal method when considering overall cost as opposed to traditional cost. Traditional cost, the fee itself, ignores the price of acquiring the resources to create the goods, the transportation of the goods, the required labor, and the actual transaction. Opportunity cost takes into account profit, production costs, and the potential of alternatives. In our example, Beckham cost €37.5M. However, further examination indicates that his purchase came at a much greater price, not just monetarily but competitively.
The initial monetary amount of this cost, without taking anything else into consideration, is a €17.5M loss. The Galácticos also lost the league that season (by 7 points and finishing in 4th place) with Beckham and without Makélélé after having won it the previous season (by 2 points) without Beckham and with Makélélé. In every on-field aspect they were poorer for the transfer. The commercial benefit of contracting a superstar like Beckham was astounding and shown in their elevated international status, but that same reputation took a hit as Real Madrid failed to even reach the Champions League final— Pérez’s Holy Grail and last won in 2002— during this era while Makélélé went onto win the Premier League twice with Chelsea in England. Monetarily, the opportunity cost is the difference in transfer fees, Beckham’s higher salary and bonuses compared to Makélélé, and the financial loss of not winning La Liga or the Champions League. This was mitigated by impressive commercial revenue, but that also coincides with the presence of other superstars on the team like Zidane, Figo, Ronaldo, Raúl, and Roberto Carlos. With Makélélé the team succeeded both on and off the pitch. Without him, they did not. Both sectors, the front five and the back six, of their “business” (the team) had been running well which translated to an efficient business, but when they tried to improve one sector past its optimal point that sector faltered, as did the whole business. That was not the extent of the damage however, because in their desire to increase on excellent returns they made a choice— Beckham over Makélélé— that resulted in lost success and potential. They had “Too many cooks in the kitchen” or as Zidane asked, “why put another layer of gold paint on the Bentley when you are losing the engine?”
Beckham’s arrival was a prime example of adding another element of production but obtaining a worse outcome. Individually, this team could perform but collectively they were no longer operating at optimal capacity. Another way to look at is when a choice is made, option A (Beckham) is picked over option B. The loss of option B (Makélélé), and all the potential it held, represents the opportunity cost. Here, the law of diminishing returns is the addition of Beckham to an already efficient front five. The “too many cooks in the kitchen” theory is the ultimate example of the law. Instead of allocating the money given to an unnecessary extra cook in the kitchen (where optimal production has been reached) into, for example, augmenting the salaries of the waiters in the dining room, the manager decided to add another factor into the kitchen and as a result, the productivity was negatively impacted. Pérez added another cook to the front-five-kitchen and this resulted in an imbalance and eventually hurt the kitchen, the back-six-dining room, and the team-restaurant as a whole. Pérez learned that when the full scope of a decision is not considered disastrous results may follow: too many cooks in the kitchen… can burn the restaurant.
*Data obtained from Transfermarkt.com