The annual capital budgeting process, while a critical planning tool, can encourage second-rate investment proposals and lackluster ROI.
It’s almost February and year-end duties are winding up. Now we can focus on getting new things done!
So, where’s this year’s capital budget? One of my ideas (systems upgrade, capacity expansion, new product development, etc.) survived the annual budgeting massacre. Now I need to get the paperwork done on a full business case proposal.
Whoa! That is NOT a healthy attitude for capital decisions! That budget creates powerful biases that will produce second-rate investment proposals and lackluster ROI.
Spending Under The Influence
Most items submitted during annual budgeting receive only back of the envelope analysis, which makes sense. At this point we are only allocating time to study the most promising ideas. Even so, I quickly fall under the influence of three powerful traps:
- Loss Aversion: Those dollars are allocated to me. They’re mine. If I don’t ultimately get to spend that full amount, something is being taken away from me (and, horrors, might even be given to another department). Behavioral research has demonstrated this unconscious bias produces very, very poor decisions.
- Anchoring: Once I have an idea in my head, it’s amazingly difficult to let it go and plunge back into a disciplined decision process with an open mind. My mind says we already have the right solution and just need to prove it. Why look for anything better?
- Fear: Let’s see… my peers, my boss, and possibly the CEO know my name is attached to this idea. I can’t come back proposing a completely different solution – people might think I don’t have good business instincts!
Teams are primed to just get final approval for the fledgling ideas that survived the budgeting cycle. However, between one-third and one half of the time, substantially better solutions are waiting in the wings. We just to resist blind momentum, start with a clean slate and seek a better solution.
Leadership can guard against these budgeting traps:
- Hammer home the message that the budget is only permission to investigate these ideas with all appropriate disciplines.
- Expect better. “Success” is often a different conclusion when the goal is making sound decisions. See Redefining Success
- Loudly praise the teams that come back with more innovative proposals. Only when I trust my leaders to view revised ideas as a sign of strength and not weakness will I willingly seek a better idea to overthrow my original one.
One parting note: Check the results. If, at the end of the year, most ideas were approved relatively unchanged from their original budget description, we’ve been spending under the influence.