If your top salespeople exceed their sales targets, do you raise those targets for next year? What happens if a positive bump was only temporary and your best talent is left discouraged by performance goals that are ever harder to reach? In other words, what is the best way to set targets that motivate, help with planning, but don't fall prey to the "ratchet effect"?
IESE prof Tony Dávila alongside Carmen Aranda and Javier Arellano of the University of Navarra, studied ratcheting and target setting over five years at a large retail travel company. The company was comprised of 376 branches, located in 18 distinct regions, all of which sold the same products, had a similar size and complexity, and had similar marketing and operations practices. Comparing the branches' performances and target setting practices over five years allowed the researchers to glean some very practical insights. The coauthors found that:
• Employees avoid exceeding targets if they know it will inflate future expectations. Too often, work targets are routine adjustments based simply on historical performance. Once employees recognize the predictable pattern, they may deliberately limit their efforts in a bid to temper future goals. This is known as the "ratchet effect" and it gets in the way of optimal firm performance.
• Setting relative targets, based on comparable peer performances and benchmarks, is better than looking at individuals' past performances alone. Relative target setting can incorporate information from other branches, divisions and even industry competitors. Relative target setting improves the quality of supervisors' targets for better results.
• By having more information to work with -- information that looks sideways and not just at the past to set goals -- companies can reduce the negative effects of ratcheting, while motivating employees more effectively to maximize efforts for everyone's benefit.
Better Information, Better Targets
For supervisors, it is key to know if great results come from temporary or permanent improvements.
Comparing performances with a reference group or benchmark is useful for determining whether performance gains (or losses) are temporary or permanent. Here, the 376 branches of the single travel company were very useful. By looking at comparable units, savvy managers were better able to determine the weight of past performance and could control the level of ratcheting accordingly.
Increased efforts by employees are considered temporary because there are limits to how much individual effort can be increased over time. If targets are ratcheted up, extraordinary (distorted) efforts cannot possibly be sustained over the long run. In contrast, savvy managers look to a firm averages to limit ratcheting if their employees' gains came from extraordinary individual efforts.
In contrast, when productivity gains stem from greater efficiency, such as the introduction of new technology, they are more likely to persist. Ratcheting targets upwards goes better with permanent efficiency gains, when a rising tide is lifting all ships. In this scenario, individual employees tend to recognize that limiting their own efforts will have a limited impact.
A version of this article first appeared on IESE Insight.
