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The Psychology of Business Plan Blunders

Writing a good business plan is never easy. But by being aware of common psychological traps, entrepreneurs and managers can improve their business planning.

Accordingly, as you make plans for your business or other ventures, consider and work to avoid these common mistakes:

Availability Bias

Availability bias refers to the human tendency to base planning on data that are easily available--rather than on the data that's really needed.

In the case of a business or new venture plan, for example, one can all too easily overweight data that's easily available because of personal experience in a past job or business. Or one can overweight data that's easily available because the information resides in some published report or white paper.

The obvious problem here is that availability does not mean relevance. The upshot? Entrepreneurs need to work hard at thinking about the data they really need for a particular plan. Then, after that, they need to work hard to get as much of that information as they can.

Hindsight Bias

Hindsight bias, another common snafu, refers to the tendency to think something is more likely to occur after the event has already occurred rather than before the event occurred.

If something good for a particular planning scenario has just occurred, most people tend to think that particular "something good" is more likely to occur again. Or, if something really awful has just occurred, again, people tend to think that same "something awful" will occur again.

One way to try to mitigate hindsight basis in your business or new venture plan is to carefully assess any simple extrapolations baked into a business plan. Such extrapolations can (in an almost hidden way) sneak hindsight bias into forecasts and planning.

Induction Problems

Induction problems crop up when people make generalizations on the basis of information that's way, way too skimpy.

Gross generalizations about all of a firm's potential customers, for example, might be made on the basis of a tiny unrepresentative sample. Or, as another example, small coincidences might be blown out of all proportion and suddenly be "discovered" as a meaningful, significant pattern.

Induction problems can be hard to address--because oftentimes good data is so scarce during the business planning process. But one tactic to minimize the problem of induction is to explicitly document key generalizations. Keeping these generalizations explicit may force continued discussion and assessment.

Confirmation Bias and Heuristic Affect

Confirmation bias and heuristic affect refer to two separate but similar thinking booboos that affect all too easily an entrepreneur's business planning.

Confirmation bias is the temptation to look for data that confirms our initial gut feel. For example, thinking a new venture will become a huge success may cause the business planner to look more earnestly for bits of information that confirm this upfront impression.

The heuristic affect occurs when preconceptions interfere with assessments of a particular business opportunity. For example, a preconception that a particular product or customer category is unprofitable may screw up or screw with the calculations used to forecast profits and cash flows of that category.

Fighting confirmation bias and the heuristic affect often requires as much as anything simple honesty. Carefully considering the negative business planning affect of our gut feels and preconceptions may be the only practical way to avoid these two errors.

Contamination Effects

A final, quick word about contamination effects and the business planning process...

Contamination effects appear when a business planner allows irrelevant but tangentially related information into a plan either directly or indirectly. For example, an entrepreneur planning some technology venture may allow a recently read book about the history of Microsoft or Google to deeply influence his or her planning.

Avoiding contamination effects completely may be impossible. People soak up all sorts of data and pseudo-data all the time. But one probably wants be alert to the contamination effect problem--especially when one is doing something as important and strategic as business planning.

About the author:

Seattle CPA Stephen L. Nelson edits and publishes the popular subchapter S corporation informational website, S Corporations Explained. Nelson is also the author of the small business best-seller Quicken for Dummies.