Can we let you in on a little secret? There’s a proven, scientific reason that the numbers in your annual budget aren’t all that different from the original proposal—even if your finance team pushes back on every figure and tests every assumption. It’s the same reason this year’s budget hews pretty closely to last year’s, though those numbers might not make the most sense.
The culprit that makes it so hard to shake free of your budget’s starting point is called anchoring. Anchoring is a psychological bias in which one piece of information sticks in your mind and influences future information. In other words, the number you start with becomes a reference point that can dramatically shape the number you end with—even when that starting number is absurd.
The power of numbers
Take, for instance, a study in the Journal of Personality and Social Psychology. Researchers asked half of the study participants whether Mahatma Gandhi was younger or older than nine when he died. The second group was asked whether he was younger or older than 140 when he died. The answer to both questions is absurdly obvious, but when participants then guessed Gandhi’s actual age when he died, the first group guessed 50. The second group, which had the number 140 in mind, guessed 17 years older, putting his age at 67. That shows the power of having even the most irrelevant numbers in mind when working with figures.
Now imagine sitting in a budget-planning meeting where you’re staring at last year’s numbers while trying to make decisions for future planning. Even if you apply careful and measured scrutiny, anchoring can have a subconscious sway over the final outcome. And this natural bias is so powerful and persistent at holding that original information in your mind that most management techniques to combat it seem like sleight of hand. Zero-sum budgeting can sometimes do the trick, but it’s a time-consuming and intensive process.
The quickest and easiest way to force this psychological bias to loosen its grip on your budgeting process? Re-anchoring. That means bucking the habit of starting this year’s budget by looking at last year’s line items and instead grounding the discussion in a different set of facts. Think of re-anchoring as an inertia killer—one that’s capable of taking your budget talks to the next level and making hard conversations more productive. You can break the re-anchoring process into three steps:
Step one: Decide what determines performance
Resist the urge to use past performance as any type of metric. That would anchor your thoughts to the status quo. Instead, decide what criteria your team would use to define what’s possible if last year’s numbers didn’t exist.
If your technology company is looking at customer acquisition, for instance, that might mean gathering data on the size of the market, the current market share, the head count of the sales team, and the current cost to acquire each customer. For a manufacturing firm looking at output for the year ahead, the data might span current market size, projected market growth, current competitive position, and a composite metric for competitive intensity. Data from public competitors can be especially helpful, because it provides more context around industry performance.
Step two: Estimate future potential
Now that you’ve identified the criteria around what’s possible, estimate what’s achievable. Again, start with the information you’ve gathered—not past performance—to better ensure you’re not shortchanging your targets. There are many modeling techniques to estimate potential, but the simplest is typically a statistical regression based on your criteria. This isn’t intended to be a predictive model, so a speedy crunch of the numbers is sufficient to give your annual budget talks a fresh starting point.
Step three: Calibrate and confirm
Let’s say you’re looking at sales estimates across a number of regional markets. If your estimates are dramatically off base for the vast majority of your offices, there’s likely something amiss in the data or criteria you’re using. But if the estimates are only out of step for a few regions, it could mean that those locations are performing far below their potential. Instead of talking about beating last year’s sales by 5 or 10%—and anchoring the next budget to the past budget—you can shift the conversation to how to achieve the fresh estimate. In other words, the model acts as a re-anchor to orient talks away from the past and toward potential.
Re-anchoring isn’t a cure-all, of course. But it can be a starting point to break free from the inertia that bogs down most budgets. And it can naturally reinvigorate budgeting talks, replacing stale numbers with a fresh eye for the future.
Want more tips to shake free from the status quo? Check out the eBook “Making the Shift: Four Secrets Behind Great Budgeting and Planning.”