Following my recent discussion of measure selection, this months column focuses on target setting, a topic equally important and no less challenging than measure development to support an effective performance management system.
Setting targets is a delicate task. If achieved, targets should define performance that will transform the organization. The challenge for managers is to set the bar high enough to drive an ambitious level of performance without adversely affecting the workforce in terms of morale or behavior. However, old approaches have failed. Thus, target setting is undergoing a revolution in organizations as they explicitly begin to transform their planning and performance processes to drive strategy execution and value creation.
Traditionally, targets are used in planning processes to establish explicit performance outcomes. They represent commitments or contracts by the organization to achieve specified, fixed outcomes. The traditional budgeting process is an example of this approach. Budgeting is invaluable when used for establishing detailed plans for projects, investments and initiatives. However, business unit budgeting is now seen as a poor vehicle for target setting. Going into the target-setting process, the budget is seen as a suboptimal, political and negotiated compromise that puts a ceiling as well as a floor on performance. Coming out of the process, the assumptions that underlie the fixed budget targets often change rapidly in todays highly competitive and globalized business environments. In other words, budget-based targets are neither ambitious nor realistic enough to motivate high performance. For these reasons, as well as the recognition that traditional budgeting is time-consuming and low value-add in terms of generating business insight, organizations are turning to alternative approaches to setting performance targets.
The primary alternative to the budget for target setting is the balanced scorecard, an approach associated with Robert Kaplan and David Norton. This approach defines targets in terms of a limited set of strategic value drivers. The scorecard replaces fixed budget targets with stretch targets that represent the key outcomes of the strategy the organization is pursuing. These strategic or stretch targets, in turn, help establish subtargets for operational performance in cause-and-effect terms. The value of this approach is that ambitious and aspiring goals can be directly linked to clearly defined drivers of performance that the organization can understand, buy into and deliver.
Today, organizations are increasingly defining aspirational targets, or big hairy audacious goals, for themselves. For example, one major retailer told Wall Street it planned to double revenues in five years. A major pharmaceutical company said it will regain its historical level of profitable growth in three years - in an industry with a decade-plus product development cycle. Goals like these, of course, cannot be arbitrary. They must stem from a clear understanding of competitive and investor benchmarks. Once established, however, they are the sky hook for establishing stretch subtargets for operations throughout the organization.
As already suggested, benchmarks, both internal and external, can be useful resources for establishing stretch targets. Financial stretch targets should typically come from external benchmarks as organizations strive for performance that will place them among industry leaders in terms of profitability, revenue growth and productivity. Many customer-outcome metrics such as market share or share of customer wallet are by definition benchmarked against the industry. Additionally, companies can survey key customers regarding their performance on various customer satisfaction metrics and ask to be ranked against the competition. Benchmarks can again helpful in establishing key operational drivers such as product innovation, supply chain management, market research and employee skill levels. Process measures, particularly those relating to time, quality and cost, can be benchmarked against industry-leading practices or against internal best practices and top-performing units within an organization.
The benchmarking approach is valuable because it relates target setting to objective and competitively relevant standards of performance. However, benchmarking must be used selectively. Not all targets have useful external analogues nor should the level of performance of competitors in specific processes always determine the goal. In some cases, the process simply is not strategic; in others, the strategy requires innovation to exceed existing levels of performance. In the end, the value drivers (scorecard themes) of the strategy must determine the stretch targets.
Selecting effective stretch targets is not an impossible task, and the target-setting exercise itself can provide significant strategic insights. By using internal and external benchmarks to guide the target-setting process and by ensuring managers are motivated to achieve ambitious, long-term goals, you can increase your organizations ability to achieve breakthrough results.