Better Business Through Better Judgment

By K.K. Merriman, Ph.D.
Thursday, September 1, 2005; 2:30pm EST

The future success of your business hinges on the quality of the decisions you make today. It�s not as critical to have good business judgment as it is to avoid poor judgment. Average quality decisions may slow growth, but it�s the mistakes that bring a business down. There are two common judgment traps in particular to avoid: Anchoring and Investment Traps.

Anchoring
The average home business has a 75% chance of success. What do you estimate as your chance of success? What if I had told you the average home business has a 25% chance of success? Does your estimate change?

Individuals are heavily influenced by �anchor� values. We use the anchor as a starting point and then adjust our response around it, both consciously and subconsciously. This process can be very helpful at times. It provides a decision making short-cut by narrowing the range so we don�t have to consider all possible values. The problem occurs when anchors are misleading.

Misleading anchor values can unjustly influence your perception of a fair price or a good deal. This is very common in negotiations where the opening side sets a starting point at a high or low extreme. They probably don�t expect to get the extreme number, but it helps steer you towards that end.

Most of us are on the alert for this during formal negotiations. We are less aware of anchors in other daily business decisions. For instance, what fee we charge customers may be anchored in our start-up rate - that low rate we offered when we had no clients and were anxious to attract business. It�s time to reevaluate that anchor. What we decide is a fair price to pay for supplies or equipment may be anchored in our last purchase. It�s better to compare current market prices. Computers aren�t the only item to have dropped in price over time.

The key to avoiding anchor traps is to first recognize the influence an anchor is having on your judgment. Remember, many times anchoring occurs at a subconscious level. Once you�re actually conscious of the effect, you can simply evaluate the anchor and determine its usefulness.

Investment Traps
Joe Entrepreneur joined a professional organization six months ago in hopes of networking for new customers. Joe paid a large initial joining fee, monthly dues over the past six months, attended ten meetings, and did a free guest speaker session for the group. It�s gradually become clear though that the chances of gaining new customers from this organization are very slim. Should Joe continue paying monthly dues and actively finish out his annual membership or end his membership immediately?
What if Cathy Entrepreneur was contemplating newly joining the same organization? Should she invest money and time in this area?

Regardless of your answer for Joe, it likely took some consideration on your part, whereas an immediate �no way� should have come to mind with Cathy. This is known as a sunk cost effect.
Once time, effort, and/or money are invested towards a goal we are naturally reluctant to lose these �sunk costs�. This reluctance keeps many of us in business situations that are no longer ideal, as if by staying in the situation we can somehow justify or recoup our investment. The larger our investment, the more determined we become to stay the course. So when what started as a smart investment devolves to something less desirable, we are very slow to cut our losses and walk away.

The key to avoiding investment traps is to reevaluate situations in the present, without undue consideration given to past investment. Ask yourself: Would I pursue this course of action if I was freshly presented the opportunity today? Given this perspective, you might get rid of a draining client, dump a losing investment, or drop an under performing business pursuit. If you�re still reluctant to cut your losses, remind yourself that time and money are limited resources. You want to invest your resources where they can get the maximum return.

It�s said that better judgment comes from experience. Fortunately, it doesn�t have to be your own experience. Anchoring and investment traps have been identified and examined by academic researchers extensively. Put this knowledge to use and it will vastly improve the quality of your business decisions and ultimately increase the success of your business.

About the Author
About the Author: Kimberly Merriman is a business writer and educator based in Philadelphia. She can be reached at kkm@kkmerriman.com.