Here is an excerpt from an article written by Michael E. Raynor and Derek Pankratz for Harvard Business Review and the HBR Blog Network. To read the complete article, check out the wealth of free resources, obtain subscription information, and receive HBR email alerts, please click here.

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Has your company inadvertently set a goal with just a 1-in-20 chance of success?

That can happen all too easily, and the consequences are potentially serious. Setting financial performance targets that are too aggressive can mean that even the best efforts go unrewarded, leaving people demoralized. Worse, in an attempt to meet unrealistic targets, people may feel increasingly tempted to cut corners or to resort to unethical or illegal behaviors that they would otherwise be loath even to contemplate. Setting overly conservative goals is hardly an alternative, however; they can leave money on the table, leave people unmotivated, and lead to accusations of sandbagging.

For better goal-setting, it will help to understand where financial targets typically come from. Often, they’re based on past performance. But a company’s recent track record says nothing about how much its performance could or should improve; what’s needed is a useful assessment of a company’s probability of future success.

One way to think about the likelihood of hitting a given performance increase is to consider how frequently other companies have made similar improvements. Using more than four decades’ worth of data on U.S.-based public companies, we constructed a table that captures the frequency with which companies have moved from one relative performance rank to another in one year on a given measure. (For more on our approach to estimating relative performance ranks, see our earlier post. We believe that we can help you estimate the probability of success for your company’s goals. See the Deloitte Exceptional Performance website.)

For example, all else equal, the probability that a company will improve from the sixth decile of revenue growth (meaning that it’s better than six-tenths of companies, adjusted for industry and size) to the seventh (meaning that it’s better than seven-tenths) is 35%. In contrast, going from the sixth decile to the ninth (meaning better than nine-tenths of companies) is just 6%. The chart shows an abbreviated version of the “transition matrix” for ROA, with probabilities of advancing from one relative level to another expressed as fractions of 1.

This population-level analysis says little about what your company will be able to do, but it does provide an objective and quantitative way to know what’s been possible and feasible for other companies. Rather than relying on potentially impracticable targets such as “Take last year’s performance and add 10%,” you can use an assessment of the probability of success to anchor evaluation of performance-improvement strategies.

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Here is a direct link to the complete article.

Michael E. Raynor is a director in Deloitte Services LP. He is the coauthor, with Mumtaz Ahmed, of The Three Rules: How Exceptional Companies Think (New York: Penguin Books, 2013).

 

Derek Pankratz is a manager in Deloitte Services LP.