Set growth objectives that won't lead employees astray

Corporate ambitions can spark great accomplishments. But they also can lead to unethical behaviour when managers and employees take excessive risks in pursuit of those growth objectives, or even impede performance in a workforce that feels defeated by targets that seem out of reach.

"It's not hard to come up with examples where [growth objectives] were directed to something beneficial but ended up causing unintended consequences," said Mitchell Neubert, professor at Baylor University's Hankamer School of Business in Waco, Texas.

Recent examples include US financial services company Wells Fargo and German automaker Volkswagen. Employees in Wells Fargo's retail banking business opened accounts without customers' authorisation to increase the average number of Wells Fargo products per banking household. And Volkswagen engineers used technology to get around emissions tests and sell more diesel vehicles in the US. Both companies lost customer trust and agreed to pay large fines in 2016 and 2017. Wells Fargo's financial performance also suffered in the first half of 2017 partly as a result of increased legal and regulatory costs stemming from the opening of the fake accounts.

"[Setting objectives] is good," Neubert said. "But are you prepared for what you get? We have to be careful not to take a too narrow view."

Companies that have hired the right people and trained them properly can avoid unintended consequences by scaling back on specificity and difficulty on tasks that are complex or require learning, by having employees participate in the corporate setting of objectives, and by leaving room for employees to exercise their judgement as they work toward them, he said.

A stretch objective that could backfire would be, for example, to give call-centre employees a challenge of averaging two minutes per call. The specificity and the length of each call may target a maximum number of calls per employee, Neubert said, but a likely unintended consequence is frustration amongst customers and call-centre employees, because little can be learned and resolved in two minutes. An alternative way to phrase the objective, he said, would be to tell call-centre employees, "Do your best to solve a customer's problem to their satisfaction in the shortest amount of time possible." Both customer satisfaction and the time on the call could be measured and used as feedback, but pressure to limit time on the call regardless of the circumstances would be reduced.

Objectives that are unbalanced run the risk of being counterproductive, especially if they do not account for important and long-term aspects of performance that may be hard to measure, such as employee learning, creativity, or collaboration, he added.

Just as counterproductive are stretch objectives that threaten punishment such as being fired or getting a poor job performance rating if they are not met, said Bonnie Hancock, an enterprise risk management (ERM) expert at North Carolina State University, where she is executive director of the university's ERM Initiative.

"If a company really has to set stretch [objectives]," Hancock said, "it has to be careful not to be punitive if those stretch [objectives] aren't met."

GOING BEYOND NUMERICAL OBJECTIVES

Wrays, an Australian firm of patent and trademark lawyers established almost 100 years ago, is well aware that rapid expansions carry risk. The firm focused on aggressively growing its client base, especially in its Sydney and Melbourne offices, since the Australian government released plans last year to support economic growth through entrepreneurship and innovation.

"While income and profit are very important, without first delivering quality of service, we would not be serving our clients' needs," said Robert Pierce, ACMA, CGMA, the CEO of Wrays.

To further its growth objectives and accommodate clients frustrated with high hourly charges, Wrays has set fairly modest hourly rates for its services. Bonuses for Wrays's professional staff start at 5% above targets, Pierce said. To make sure the quality of service doesn't suffer, Wrays surveys its clients every month. Survey questions include inquiries about whether clients' emails and calls are answered promptly. Clients are also asked whether they would refer Wrays to peers, and their responses are tallied and tracked monthly at the board level.

"You have to have some measurable objectives, but you also have to take into account some qualitative factors and some judgement," Hancock said. "If you're just blindly following numerical [objectives], you might hit the [objective] but miss the mark in terms of what you're trying to achieve."

KEY INGREDIENTS OF SUCCESSFULLY SETTING OBJECTIVES

Planet Blue follows a multi-step process to make sure objectives remain realistic. The Los Angeles-based women's clothing retailer, which embarked on an aggressive expansion a few years ago, operates 16 stores across the US.

The pay of store sales staff is commission-based, said Planet Blue adviser Katrina Basic, CPA, CGMA. That means store-wide sales targets are aggressive by nature. But, she says, "if we set [targets] that are too difficult for the teams, then they are not motivating."

Store-based target-setting at Planet Blue starts with a planning session to explore growth objectives for each store that considers factors such as customer demand, sales, rent structure, and operating costs. These growth objectives are then adjusted in a back-and-forth dialogue with sales managers and employees working at the stores.

Setting objectives starts with the executive team, which proposes sales targets based on each store's rent structure and general operating expenses. The proposals are shared and discussed with the sales team and store employees, and adjusted if the sales force considers them unrealistic. The final objectives become the road map for the direction in which the company is heading.

"It's making sure that everybody understands the [objectives] from the bottom up, takes ownership, and has belief in them," Basic said.

Aligning objectives with store performance and getting agreement on them from the sales force are two ingredients in successfully setting stretch objectives at Planet Blue. Corporate culture is another. Creating a sustainable business long term is important for the retailer, and the targets and incentives reflect that, Basic said.

For example, Planet Blue won't spend lots of money bringing customers to its website just to make a one-time purchase. Instead, the retailer focuses on customer service because it values repeat customers who become evangelists of the brand.

"We look at [objectives] that are bottom-line-driven," Basic said. "When you just have [objectives] that are incented on top line, that can have a negative consequence."

At Planet Blue, the objectives represent a road map that sets the direction in which the business is headed. Incentives reinforce the direction based on how the business is performing. Key indicators tracking performance include the average price of items sold, the number of items customers buy, and how many customers who enter a store or visit the website make a purchase.

The measurements also help the company understand why certain targets are or are not being met and adjust them if necessary, Basic said. "An annual [target] breaks down to monthly to weekly to daily, so we can have that dialogue pretty frequently and see when we're off track or when we are exceeding the [targets]," she said.

Internal controls, such as sales audits, are done at Planet Blue to ensure that, for example, employees aren't creating fraudulent sales. But Basic considers the collaborative way the company sets and adjusts revenue targets as critical to preventing employees from gaming the system to meet objectives. (See the sidebar "4 Tools to Keep Bad Behaviour in Check" for tips on how to set appropriate goals and avoid problems in their implementation.)

"If you design [the objectives] right, if you have the right corporate culture," she said, "you're going to get the behaviour that you want."

HOW TO STRUCTURE INCENTIVES

Once the objectives are set, the next step is to structure quotas and incentives. How they are designed and implemented is important to avoid undesirable behaviour. Here's an example of how to use sales to increase profits:

• Base incentives on the group rather than an individual to minimise internal conflict.
• Relate quotas and incentives to profitable sales and to sales of higher-margin products and services. Sales of advertised, promotional products should not be included.
• Consider making quotas and rewards voluntary, not compulsory. If the reward is sufficiently attractive, be it monetary or non-monetary (promotion, reassignment to a more desirable location, sabbatical), there will always be strivers making the effort, and that group should receive the biggest reward.
• Recognise that one size reward does not fit all. Employees at the lower end of the compensation scale may be motivated by cash, but managers and executives at the upper end of the scale may be motivated by non-monetary rewards.

4 tools to keep bad behaviour in check

To ensure performance goals are appropriate and to detect bad behaviour as the goals are implemented, Bonnie Hancock, executive director at North Carolina State University’s ERM Initiative, suggests using the following tools:

Balanced scorecard

To tie business activities to the organisation's vision and strategy, a balanced scorecard offers a framework that provides executives and managers a balanced view of organisational performance. Multiple measurements are used to monitor performance against multiple strategic goals.

Wells Fargo, for example, got into trouble relying too much on one performance measurement — eight products per customer — to determine the success of its cross-selling strategy. A more balanced approach would have included consideration of other indicators towards its strategic goal, which, Hancock said, was probably cementing deep customer relationships.

Periodic surveys

Polling customers or employees is a tool to measure interactions and, depending on the questions asked, can also be used to collect qualitative opinions. In Wrays's case, the customer surveys help determine whether clients are satisfied with the firm's service.

Employee surveys can be used to gauge how lower-level employees interpret management's risk appetite, Hancock said. Employees are asked, for example, which trade-offs they are willing to make in pursuing specific goals. The responses help determine whether there's a gap between what employees do and what management would want them to do.

Pre-mortem analysis

To test whether a goal may trigger unintended and unwanted consequences, a pre-mortem analysis starts with the assumption that the worst possible outcome that could occur has happened. The potential trigger is found by backtracking and analysing what could have caused the outcome.

Once potential bad behaviours are identified, ways to prevent or detect them can be built in, Hancock said.

Periodic audit

Companies that have completed pre-mortem analyses and installed controls to detect bad behaviour can then perform periodic audits of a sample of transactions that count towards a certain goal. These risk assessments, such as the sales audit done by Planet Blue, would have to be done before annual audits to determine incentive compensation.

Sabine Vollmer is a CGMA Magazine senior editor. Marvin Weiss is a retired professor of accounting at the New York Institute of Technology.