Setting the

Right
Stretch
Targets

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved.

Table of contents

Introduction Page 3
How Much Should We Stretch? Page 4
When Should We Stretch? Page 7
Where Should We Stretch? Page 9
Conclusion Page 11
About This Research Page 11

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved. 2

Introduction
Finance leaders repeatedly struggle to set performance targets that balance ambition with
reality. In fact, only about half of business and finance staff think the performance targets they
receive are fair and achievable. To help finance leaders set more reasonable stretch targets,
we investigated how companies avoid overstretching and understretching.

What are “stretch targets”? They are ambitious performance targets that require businesses to
do something qualitatively different from what they have done before. This can mean different
things depending on industry, company size and past performance, but stretch targets are
largely meant to incentivize business leaders to deliver improved results. In today’s high-growth
environment, setting stretch targets has become a fairly common practice. In some cases,
a year-over-year flat increase in targets can be considered “stretch,” though stretch targets are
usually significantly different from prior years’ targets. Regardless of the baseline, stretch
targets push the business to exceed typical performance expectations.

Companies struggle to set stretch targets because it is difficult to balance ambition with reality.
According to a recent Gartner survey, only about half of business and finance staff think that
the full year targets they receive are fair and achievable.

Perception of Stretch Targets

as Fair and Achievable

50%

44%

Business Staff Finance Staff

n = 538 (business staff); 144 (finance staff).

Source: 2018 Performance Management Model.

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved. 3

On the one hand, complacency leads to unambitious targets that fail to push
the business, leading to underperformance. On the other hand, overly
ambitious targets can inspire unethical business practices to meet those
stretch targets. As a result, companies must be careful about how to use
stretch targets to their advantage without running the risk of poor business
behavior.

Companies need to address three basic questions to set good stretch targets:

 How much should we stretch?

 When should we stretch?

 Where should we stretch (i.e., which part of the company)?

How Much Should We Stretch?

To determine how much to stretch, finance must gain a better understanding
of the business’s ability to achieve stretch targets and look beyond immediate
industry peers when using benchmarks to set stretch targets.

Better Understanding of Business’s Ability to Achieve Stretch Targets

Problem: Mutual Distrust Between Finance and the Business

Most companies tend to set top-down targets and negotiate with the business
to arrive at the final targets. Target setting is typically a painful, haggling
exercise rather than a way to truly understand the expectations and ability to
achieve those targets. As a result, when discussing performance reviews,
there exists a mutual distrust between the corporate center and business
managers that prevents both sides from sharing the right information.

This distrust usually plays out in the following way: Because there are
penalties for missing targets (e.g., a bonus reduction), business leaders want
targets that will be easy to hit. To receive an easy target, business leaders
tend to “game” information and provide less ambitious estimates of the
business’s ability to achieve proposed targets. Finance, recognizing the
business resorts to sand-bagging, is inclined to keep the targets higher to
push the business to achieve its full potential. The typical result is a stretch
target that is not actually based in the reality of the business. In these
circumstances, businesses end up less committed to the final target.

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved. 4

Solution: Determine How Businesses Can Hit the Target

To break down some of the mutual distrust that surrounds target setting, finance must work
with business units to get a better understanding of how they will achieve the stretch targets.
Merely collecting information about business plans—as many companies do—is inadequate.
Instead, the business must make a more substantial attempt to plan out the scenarios that
would lead it to hit a stretch target. Companies can determine how to achieve stretch goals in
two ways.

The first approach is to identify business initiatives that have the potential to exceed
expectations, determine the likelihood that those initiatives will succeed and build their potential
into the targets. At insurance company Alphaa, for example, finance works with the business to
identify high-potential initiatives and establish two sets of targets: business-as-usual and full
potential (i.e., stretch) targets. Separating the two targets allows finance and the business to
see a range of possible outcomes. Finance tracks operational drivers and metrics throughout
an initiative’s development to get a realistic understanding of what is possible, which gives
business leaders more insight on how much harder they can push the business to achieve a
higher level of performance. To counter any negative effects of setting stretch targets, finance
structures business incentives in a way that rewards achievement of full potential targets but
does not penalize the business for missing them. This approach motivates business managers
to deliver performance above expectations without fear of penalty.

The second solution is to provide businesses

with a series of implementation steps to meet
stretch targets. Betaa, a property management Alpha FP&A’s Target
Achievability Questions:
company, accomplishes this by outlining
possible actions managers could take to meet
 What is our capacity to deliver
their targets. For example, if a manager
these initiatives?
receives a target to improve return on assets
by 4%, they also receive a list of recommend-  How should we prioritize these
ations to reallocate resources for advertising, initiatives?
improve their use of shared services and  Which clients are we targeting and
restructure certain leasing arrangements— what is the likelihood they will
specific actions that would help them achieve move to launch?
that target. Finance then helps monitor
 How will you deliver the initiative?
progress on both the annual target and key
implementation steps.  What are the top
aPseudonym.
interdependencies between
businesses that impact this
initiative?

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved. 5

Benchmarking Against Peers

Problem: Benchmarking Too Narrowly

Most companies benchmark too narrowly to their immediate competition and

industry peers when setting stretch targets. A 2015 Deloitte study found
executives were, on average, 20 percentiles off in their estimation of their
company’s success because they defined their industry peers too narrowly[1].
For example, a metal goods company was outperforming all other metal
goods companies of a similar size, as measured by five-year average growth.
But when company size and industry were controlled for, the company was
clearly underperforming, scoring in the 12th percentile of all public U.S.
companies.

Benchmarking data is especially useful when there is significant uncertainty

around stretch capacity, such as when past performance is unreliable or no
information is available[2]. In such conditions, competitors offer clues into
what would be a reasonable stretch target. The difficulty, however, is defining
the universe of competition. Which industry peers are most relevant? Most
companies answer this question too narrowly and end up with unambitious
targets.

Solution: Expand the Competition

To get out of narrow comparisons, businesses must expand the universe of

competition, either by benchmarking against companies that outperform the
market or benchmarking against businesses in other industries. Both solutions
help build a more realistic vision of how much to stretch.

One way of pursuing the first method is to look at trends for the very best
companies. For example, Deltaa, a retail and appliance company, does this by
looking at the historical rate of the top quartiles of the S&P 500. It uses this
information to calculate how much a company would have to grow over the
next three years to maintain a total shareholder return (TSR) that would keep
the company in one of those top quartiles. It then uses those TSR numbers to
reverse-engineer annual stretch targets for the company.

In many cases, the targets that result from these calculations are far too
unrealistic; staying at the top of the S&P 500 is rare. But this process helps
the company’s finance team start a conversation with the rest of the business
about how its targets translate into growth. The company uses the TSR
number as a guide to show where they would need to go to reach their goals.
aPseudonym.

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved. 6

To pursue the second method, benchmark against a broader range of
companies than those considered your immediate competitors. Comparing
against non industry peers provides a rough indicator of how well a company
is performing in current economic conditions—a difficult metric to see when
only comparing to immediate industry peers. If a company is outperforming
the economy but not other companies in their industry, they likely need to set
more ambitious targets.

The key is to control for differences in industry and company size to achieve a
common metric for comparison. In the Deloitte study mentioned earlier, 18%
of companies outperformed non industry peers, but not industry peers, on
revenue growth. These companies are the ones that must set more ambitious
targets. A company that is growing revenue faster than most other companies,
regardless of size or industry, is capable of meeting more ambitious targets.

When Should We Stretch?

To determine the frequency of setting stretch targets, companies must
consider the timeline of project development.

Knowing When to Ease Off Stretch Targets

Problem: Stretching Every Time

When companies decide to set stretch targets, they tend to do so continually,

year-over-year. Some companies take this approach because they view
hitting a target as an indicator the business can stretch further, while others
follow a heuristic of “always set ambitious targets.” Continual stretch
significantly impairs performance, especially when resources are stretched
thin[3].

Target “ratcheting,” where hitting a target one year leads to a target increase
the next year, is particularly problematic. A study of over 600 businesses
found that those businesses outperforming their industry peers tended not to
ratchet their targets[4]. When they hit their targets, they typically left them
unchanged for the next year. And if they missed their targets, they actually
lowered them the next year (by more than 2%, on average). These companies
believed meeting a target meant the target was appropriate, not that there
was excess capacity. Missing a target meant that the target was too ambitious
and the company should scale it back.

In contrast, companies that were at the bottom of their industry were more
likely to increase targets if they hit them and were less inclined to reduce
targets after missing them. These companies were committed to continual
stretch, regardless of the consequences.

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved. 7

Solution: Use Progress of Key Projects as an Indicator of When to
Stretch

Instead of setting continually increasing stretch targets, companies must

consider the timeline of project development. Companies usually face two
scenarios, each which requires a different solution.

The first scenario is relatively straightforward. Here, a company sets an

extremely ambitious target one year to stimulate growth, which requires the
business to make considerable changes and expend significant resources to
meet the target. As a result, it lacks further capacity to grow in the short term.

In such a case, the next year’s target should be reduced to give the business
time to compensate for trade-offs it made the previous year. Even if the
business seems to meet the target effortlessly, there are usually knock-on
effects that won’t become evident until the second year. Once the effects are
well-understood, stretch targets can be reintroduced in the third year.

The second scenario arises from new initiatives, which can take several years
or more before beginning to deliver significant returns. Setting stretch targets
too soon (i.e., before the initiative has matured) will cause major setbacks and
can derail the project. For example, suppose a company has accurately
estimated a new initiative will bring in $800 million over 10 years. It would be a
huge mistake for the company to set steadily progressive targets from year
one to year 10 (e.g., $50 million in year-one revenue and 10% increases
every year)[5].

Instead, the company must consider the timing of key steps in the project.
The first few years will benefit from undemanding targets as the project
progresses. Once the foundation has been built, stretch targets will incentivize
business managers to push the project to full potential.

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved. 8

Where Should We Stretch?
To avoid the negative consequences of overly focusing on the short term,
companies should distribute risk across business units and strategically
stretch only those businesses that are in good financial health.

Knowing Which Part of the Business to Stretch

Problem: Blanket Stretch Targets

Most companies stretch too many of their business units at the same time.
For example, it is common to see companies assign a flat percentage
increase in performance targets for every business, regardless of the previous
year’s performance or next year’s portfolio. They follow the same heuristic
mentioned earlier: always set ambitious targets.

The main problem with stretching every part of the company is its risk factor.
To meet a new, ambitious target, business leaders must take risks they
normally would not take under business-as-usual circumstances. Annual
targets also promote a focus on only that year’s target, at the expense of
long-term success. Incentivizing risk taking and focusing on short-term results
introduces significant risk if implemented in every business unit
simultaneously.

A 2017 study illustrates the way stretch targets alter the type of risks business
leaders are willing to take. The study used simulation techniques to mimic
business decisions for a commercial airline company, including the annual
target-setting process[7]. Some people were given a cumulative net income
target of $315 million to hit over 10 years—a stretch target—while others were
given a target of $60 million over the same time period.

The results showed those given stretch targets did not perform better, on
average, than people with moderate targets. More importantly, there was
significant variation in performance for those given stretch targets. One
participant raked in over $700 million, which might seem to justify stretch
targets, but only four people hit the stretch target while nine actually went
bankrupt.

This data suggests the risky behaviors that stretch targets encourage may
only work out in some situations—not all. Most people who were given stretch
targets made decisions that ended up hurting the business. Managing for
stretch targets led them to make too many risky trade-offs that they weren’t
able to recover from. We can expect similar behaviors in the real world when
companies incentivize business managers to make whatever changes are
necessary to meet a highly ambitious target.

© 2018 Gartner, Inc. and/or its affiliates. All rights reserved. 9

Solution: Distribute Risk From Stretch

To avoid the potential negative consequences of stretch targets, companies

should distribute their risk. Trade-offs and reprioritization are often required to
meet stretch targets, but not every business unit can do this simultaneously.
To ensure businesses make the right trade-offs, it is important to determine
the cross-company effects and identify businesses most capable of taking on
extra risk.

For example, Gammaa, a food & beverages manufacturer, asks key business
units to propose long-term strategic plans for expanding in specific markets.
Finance then helps evaluate these proposals and determine the resources
needed to make the projects successful.

To illustrate, proposals might be considered for a new food product and a new
beverage product line in North America. Finance collects information needed
to determine if each plan is too ambitious, including the timelines for other key
product lines in North America. They evaluate whether resources can be
combined across product lines and helps prioritize markets and product lines
for receiving stretch targets. The end result is clear visibility into all the
different tradeoffs involved in achieving each stretch target.
aPseudonym.

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Conclusion
Stretch targets are one of the best tools in the performance management
toolkit. When used well, they motivate business leaders to innovate and
enhance performance. But without the right information, targets can be
detrimental to the business, leading to reduced returns and risky behavior.

To determine how much to stretch, work with business units to determine how
stretch targets might be achieved. It is also important to expand the range of
relevant peer comparisons to help balance complacency and ambition. To
decide when to stretch, consult project development and ease off stretch
targets for extremely ambitious projects until they are ready to deliver. Finally,
to determine where to stretch, identify how to distribute risk across business
units and strategically stretch only the businesses most capable of taking on
additional risk.

About this Research

This research is drawn from the our 2018 Business Performance
Management study. We surveyed more than 200 business and finance
professionals, interviewed more than 60 finance executives and conducted an
extensive literature review.

[1] Michael E. Raynor, Mumtaz Ahmed, Derek M. Pankratz and Rob Del
Vicario, “A Theory of Relativity: Setting Priorities and Goals for Financial
Performance Improvement,” Deloitte Review 17, (2015).

[2] Henri C. Dekker, Tom Groot and Martijn Schoute, “Determining

Performance Targets,” Behavioral Research in Accounting 24, (2012): 21-46.

[3] Sim B. Sitkin, C. Chet Miller and Kelly E, “The Stretch Goal Paradox:
Audacious Targets Are Widely Misunderstood—And Widely
Misused,” Harvard Business Review, January-February 2017.

[4] Raffi J. Indjejikian, Michal Matejk, Kenneth A. Merchant K and Wim Van
der Stede, “Earnings Targets and Annual Bonus Incentives,” The Accounting
Review 89, (2014):1227-1258.

[5] See additional examples in: Rita Gunther McGrath and Alexander van
Putten, “How to Set More Realistic Growth Targets,” Harvard Business
Review, 12 July 2017.

[6] Michael Shayne Gary, Miles M. Yang, Philip W. Yetton and John D.
Sterman, “Stretch Goals and the Distribution of Organizational
Performance,” Organization Science 28 (2017): 395-410.

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