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FP&A: Confronting Cognitive Bias

  • By Bill Myers
  • Published: 11/13/2017

bias

FP&A practitioners are used to volatility. But not all unpleasant surprises are external. Sometimes, the enemy can come from within in the form of blind spots.

“Cognitive bias” is the phrase that some scientists give our blind spots. Broadly speaking, cognitive biases can take on many forms. You can probably think of plenty of examples on your own of companies or groups that either thought they knew something (and didn’t) or should’ve known something (and didn’t).

Even worse, these blind spots can lead to cascading errors. Huisman offers the mote in his eye.

“FP&A professionals will have to deal on a daily basis with cognitive biases, both their own and the business partners they work with,” said Barry Huisman, FP&A, a finance manager at a multinational company. “As a result they need to be more aware than others whether or not they are dealing with biased information. A good example here is dealing with a business partner that believes that the trend will improve, especially when though decisions need to made.”

Huisman recalled how, in a prior job, he was confronted with frequent cost overruns from one of the business units. Initially he believed that they could recover the overrun, but that did not happen. “This had a serious impact on myself and the management team of the unit, with our corporate center coming down hard on us,” he said. “My reaction in future years was that I was ultra-skeptical when it came to plans of recovering from an underperformance position and it was really hard to convince me that it was possible, so I was holding on to funds for improvement longer than needed.”

So how are FP&A professionals to know what they don’t know when the very atmosphere seems choked with unknown unknowns?

Hard-wiring problem

The fault may well be in our evolution, said Philip Fernbach, a marketing professor at the University of Colorado. “People didn’t evolve as corporate financial analysts,” he said. “There are many, many biases that end up getting people tripped up.”

Fernbach, who will keynote note AFP’s inaugural FinNext conference next March, is one of the social scientists who shy away from using the term “cognitive bias.” He prefers the term “heuristic” to refer to problem-solving models our primitive brains developed hundreds of thousands of years ago. Those problem-solving models our brains run to help us make judgments and decisions can serve us well. But sometimes they emphatically can’t—especially when those models are very large and complex, such as supply-chain forecasting.

For Fernbach, the biggest threat to careful planning is overconfidence. “A lot of overconfidence has to do with preferentially processing information in a way that favors our pet hypothesis,” he said. “We see evidence that’s consistent with it we take it and move on.”

The good news, Fernbach and others say, is that FP&A professionals are in a place to do something about them. Just as the brain can play tricks on us, we can play tricks on it, too—with profitable outcomes.

‘Where has the money gone?’

Take the case of RWE, the German electric utility that found itself short about €10 billion in the late 2000s. “In the business cases underlying these decisions,” CFO Bernhard Gunther told McKinsey for a profile last May, “we were betting on the assumptions of ever-rising commodity process, ever-rising power prices. We were not alone in our industry in hitting a kind of investment peak at that time.”

When RWE’s board inquired—“Where has the shareholders’ money gone?” Gunther quoted them as saying—officials at RWE had to do some serious re-thinking. “What became obvious is that we had fallen victim to a number of cognitive biases in combination,” he recalled.

In response, RWE adopted a formal, top-down overhaul with more formalized roles for team members to help guard against biases. There are certainly several concrete steps that practitioners can take.

Soft skills

Guarding against blind spots doesn’t have to be formal or even complex. It may be just a matter of getting out of the office, said Larry Severn, owner of the Buttonwood Group, a consulting firm.

“The FP&A people themselves know an awful lot about financial modeling, accounting, about Excel,” he said. “They know a lot about these areas so they’re good to go. The skills the people really need to learn to go the next level are the soft skills—relationship-building, how the business works.”

Recently, Serven worked with a senior analyst who thought she knew the business well but decided to go on a series of “ride alongs” with the company’s road crews.

“She thought that was only going to last about a month or so,” Serven said. “And six months in, she realized this was the best thing she had ever done. She had a much deeper, better understanding of what these crews were all about, the challenges they face, how they organized their time, how they prioritized. It went miles beyond what she was able to glean from the spreadsheets.”

The lesson, Serven said, is clear: “I think we all gravitate to things that we do well. As an analytical people we tend to gravitate to spreadsheets and financial models. And that’s great but I think if we’re going to get to the next level in terms of our analysis and the value we bring to the business, we have to go beyond that. We have to develop our soft skills so we can effectively partner with the business and in partnering with the business and much better.”

Phil Fernbach is a keynote speaker at FinNext, March 18-20, in San Francisco. Learn more here.

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