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The Not So Obvious Facets of Budgeting and Forecasting
No matter for a budget season or continuous forecasting: the human factor is randomly covered in the process that may bring the best and the worst of management culture. A special eye on bias during the Performance Management and goal setting process is essential for process quality and to the FP&A skillset.
Time to shed light on the behavioral side of financial planning. With a twinkling eye, the not so obvious psychological patterns unexpectedly surface during every planning season.
„The greatest danger for most of us lies not in setting our aim too high and falling short, but in setting our aim too low, and achieving our mark.“ (Michelangelo)
Bias and Long-range Strategic Planning
They do exist: departments that frequently fail to predict month-end revenues and pride themselves with a best practice strategic planning process. Frequency is key in both that enables FP&A to separate human-driven deviations from chance.
The 50/50 coin flip to outperform Wall Street can make a substantial count of traders start flawlessly into their 10th career year. For 10.000 starters pure luck will leave 20 on the superstar side. A coin flips to land “heads up” five times in a row has a 3% probability. This depicts the probability to overachieve a goal four times in a row by chance. To identify for this 3% chance of continuously under- or overestimating a target, the “plan and update once a year” cycle will take two years to empirically identify - with a good chance of error - a possible bonus optimized play. Actionable and timely is seeking communication earlier. This is a strategic long-range undertaking and strong argument to implement a rolling forecasting and develop a predictive skill set within the organization. The path to impactful forecasting skills set forward by Philip Tetlock is described here.
Social Loafing - of I’s and eyes in team
Alchian and Demsetz defined a theory of the firm on Social Loafing. In short: management is there to ensure equal and maximized effort in two people carrying a box.
Social Loafing is the proven and measurable tendency to lower your effort in a group effort. In a rope towing contest, individual performance shrinks from 100% towing one on one to 49% per person for teams of eight. Luckily both sides share this fate and a fraction of the muscle loss may be attributed to coordination efforts. To move away from the clockwork of task execution, suddenly attitude becomes a winning parameter in the equation of competitive edges. Transparency of individual performance annihilates the effect. Transparency is not to be mistaken for diversity. Diverse teams perform best only if diverse – and trackable - tasks are to be accomplished. The diversely skilled towing crew will show similar results.
Already separated tasks well in planning? Watch out! As responsibility diffuses on many shoulders, social loafing makes groups make riskier decisions. Yes, we all “share the burden on many shoulders” as a German saying goes. Underachievement, e.g. failing to innovate due to adequate margins, may leave a whole industry open to disruption. Transparency of the individual authority and performance is key. FP&A can support this process by ensuring transparency to drivers and proposals and providing a neutral and responsible risk assessment.
Why giving it all does not justify the effort
Justification of effort tends to mistake the value of something for the amount put in. The emotional value of restoring and maintaining your grandparent’s car does not reflect the market value. What is a budget worth, if it is created under clear expectations and without hassle?
This cognitive dissonance is found in grueling tests and membership acclamation rites where simply getting the job done and executing on it borne out of the experience is insufficient. Routine is a very good combatant of effort justification. Guidance and clear expectations may also prevent to dilute time from the most relevant tasks. Deciding on the future of the business is a daunting process enough then to be laden with self-justification.
“Planning is essential, but plans are of little use.” Winston Churchill
Neomania and the ever-new most important
Nassim Taleb states that five decades of survival are required to make a technology last. VHS and Flash were once hyped and died young. New products of digital and tangible nature are designed on wooden tables, one of the oldest construction materials.
The overstated potential of Neomania is tempting to the budgeteer. Incorporating the newest trends is a sign of being “up to date”. Yet, lessons learned and a register of risk and potential development makes transparent, that the main drivers mostly are of lasting nature.
The wish list of the “have and must to” adds to the dilemma of balancing costs and benefits of the important future potentials. A well trained and experienced brain is required more than a digital heuristic to spread the useful trends from the brief flares of high hopes. The individual assessment again a sign against weighting Neomania too high and it is not to mistaken for succession and evolution.Two short ones to consider at the end.
The Fallacy of the First Impression and the Last Words
FP&A makes extensive use and takes preemptive measures on these effects. Both are influential and the bias is used to hide a bitter truth in the middle. There it is hidden best while against public opinion: the first impression is important at an instance; the last words have a lasting effect.
To demonstrate how the brain is wired: choose John or Jim – who does your brain like better?
John who is intelligent, hard-working, impulsive, critical, stubborn, envious or Jim who is of envious, stubborn, critical, impulsive, hard-working and intelligent nature.
The Fairy Tale of Johnny peep into the Air
The Grimm’s tale on how – literally – missing prudence makes you fall deep is far fetched to explain the Opportunity Cost Fallacy. On the other side, the blind spot to measure a decision only against the current situation “in sight” and ignoring relevant scenarios “at your feet” is described well by a person that permanently ignores his feet.
Our behavior has been shaped evolutionary more than we admit. Being aware of the patterns evident in Management is as important as being aware of the digital patterns brought up by algorithms throughout our systems and external data sources. Business Partnering is a reflection of this need and it encompasses FP&A to immerse in the team while preserving the goal of providing an unbiased view into the future.