What do we really know about our businesses?

My wife makes fun of me all the time for my use of numbers. She says that if I declare my business has reached $1 million, this means we are at $750,000; if I say there are 30 minutes left in a boring trip, that means there are two hours; if I say we only have a mile to hike, it means we have another 3 miles of climbing. She has a point.

I swear I have no intention to distort reality or to mislead her (or my kids) — it’s just that I seem to have this bias that drives me to be overly optimistic. It’s not that I am not a numbers person — on the contrary. I just tend to see the numbers I want to see.

Business owners always have a bias when they look at their business, much as parents always have a bias when they look at their children and investors have a bias when they look at their own portfolios. The sources of biased judgement for investors are well-studied now and rapidly incorporated in financial planning practices, and I want to propose that a similar bias exists in how business owners process information and therefore how they make decisions. This bias can actually lead to poor decisions and, over time, create real problems.

To jump to the conclusion, the only way for business owners to eliminate their bias is to use benchmarking consistently as a way of making sure that they see the data clearly. This year’s InvestmentNews Benchmarking Study of Advisory Firms attempts to broaden the view of your business to analyze both financial performance and staffing benchmarks. Traditionally, these two topics were studied in alternate years and we explored compensation trends last year, but bias exists in all areas of the firm so we’ll look at staffing and compensation trends again this year.

Using benchmarking does not just mean participating in the 2018 InvestmentNews Advisory Study — Yes! Please do! — it means also examining the reports from the benchmarking comparisons with their trusted advisers, business consultants and coaches.

click here to participate in the 2018 benchmarking study

Optimism bias

One main source of bias every business owner has is from a sense of optimism. They say that MBAs never start a business because, if you do all the analysis, it just does not make sense to start one. Entrepreneurs tend to believe they will be successful, much like boxers believe they will win, even if their bloody face should tell them differently. As a result, when looking at the key performance indicators of a business, the owners tend to “round up” everything. The revenues appear a bit higher, the profits better and the growth faster. It is the natural sense of optimism of those who have to believe.

Frankly, this is the least of the many problems business owners face. Optimism is not a hindrance to a business; I only wish we all had more. Still, when making decisions about budgets and spending, it would be better if that sense of optimism were balanced by a whisper of reality. After all, collecting and analyzing the real numbers may lead to much better decisions.

Circumstantial bias

An even bigger problem is when owners tend to ignore problematic numbers because they feel they can explain them. It is very common for me and my colleagues to hear from a CEO, “I know last year’s growth was not where it needed to be, but that’s because Colleen left. Otherwise we would have been fine!” Or something like, “I know George’s salary is lower than the benchmark range for his position but that’s because he started with us straight out of school.”

Business owners can sometimes ignore or marginalize the importance of problems they can explain through circumstance. If there is an event or a person they can associate with the issue, they tend to ignore or discount the hypothesis that there could be a larger problem and higher level of importance.

Once again, a more detailed review of the data and the presence of an outside trusted adviser can be very helpful here. This is how we may be able to find that while there is a reason for each departure in a firm, collectively the firm is experiencing a very problematic turnover rate. Or that while every year is different, a firm has been growing much more slowly than the industry for the last five years. Explanations are not enough if the problem persists.

Limited observation bias

While excessive optimism is very characteristic of small firms, the “observation bias” plagues the largest firms in the industry. It is particularly damaging to founders (yours truly included). Founders tend to instinctively believe that they know everything there is to know about the business that they started, and they have a hard time believing that much is happening without them. In reality, however, as many of the large firms in the industry exceed 100 employees, the ability of the founders to observe what is happening at the organizational level can be very challenging.

Instead of relying on data that have been carefully gathered throughout the organization, owners can sometimes over-rely on the limited data set of their immediate experience. They tends to think what is happening to their clients is what happens with all clients. They think that what they saw in one staff meeting happens in all staff meetings. They often believe that if they went looking for Doug in his office and he was not there, that Doug is gone all the time.

We all tend to put more emphasis on data we have personally collected, ignoring that it may be limited, biased or flawed, and that the larger the firm, the more important it is that we gather information systematically and carefully before coming to any conclusions.

Pride bias

Sometimes we also refuse to succumb to reality because of sheer pride. We can’t admit to ourselves that we are not achieving our goal or that our performance has slipped. This pride can cause us to ignore data or even avoid data that reveals our own issue.

I remember shopping for new suit pants and I confidently walked over to the salesperson and asked for size 32. He looked at me, smiled and said “Sir, I think size 34 will fit a lot better!” I told him that while I am not as fit as I used to be, there is no way in a rainy Seattle day that I had slipped as far as size 34. To prove him wrong, I went to the pile labeled 32, picked a pair of pants and triumphantly walked out of the dressing room. They fit perfectly!

The salesman was perplexed. He said “I’ll be darned! I thought I had good judgement for this but I guess not” Then he asked if he could just peek at the label. I happily obliged. The label said 34 — somehow the pants had been put in the wrong pile.

To get away from the pants, I will tell you another story. A client was insisting for a while that he not be compared to firms that service $5-million clients because his target client was $50 million. Out of curiosity I calculated a number and showed it to him. It was his average assets per client and it was $4 million. What we strive to be and who we are can sometimes be disconnected, and sometimes it is good to see the gap even if it hurts our pride a little.

Scope bias

Sometimes we know a problem exists but we don’t realize how bad it has become. Many business owners experience this. They see an issue, but they are not sure it is serious until they seem some very specific evidence that they have fallen far behind. A benchmarking report is a way to recognize that your firm is not just slowing down a bit — it may be falling behind; that you are not a little less profitable but that you actually may be in danger of losing budgets and losing people. Benchmarking not only brings to light what the issues may be but very importantly, helps illustrate the levels of severity.

Fisherman stories bias

Finally, not all surprises are bad. Benchmarking may surprise you in pleasant ways. After all, you have to understand that industry meetings and conferences are often the forum for “fishermen stories.” These are stories where everyone seems to catch a giant fish every time.

You may come back from a conference thinking that you are slow to grow or falling behind in technology but when you actually compare the numbers, you may find that you are doing just fine and that everyone else may have exaggerated a bit.

No one is completely objective when looking in the mirror. You often need help in the examination and benchmarking as well as the advice of fellow business owners or consultants to help you recognize your own blind spots. Much as advisers help investors recognize their bias, industry data can help you recognize the business-owner bias.

This year’s InvestmentNews Benchmarking Study of Advisory Firms addresses the need to view the health of the whole firm and is reworked to cover vast critical areas, including financial performance and compensation. We hope you consider participating in this edition of the survey.

Philip Palaveev is CEO of The Ensemble Practice