Published on the 09/06/2008 | Written by Gary Collier

Performance management and business intelligence tools can be powerful business enablers. To make the most of them you need to start by getting your key performance indicators right…

Businesses love their mantras: ‘Retail is detail,’ ‘The customer is king’. But there is one adage which has moved beyond cliché to become a truism, and that is: ‘If you don’t measure it, you can’t manage it’.

Key Performance Indicators (KPIs) are critical measurements for organisations examining their operational performance to identify trends and opportunities for improvement. They measure progress toward pre-established goals, and where these goals are less than clear, they can allow rationalisation of core business-critical functions and capabilities.

KPIs also act as an important starting point for a performance management overhaul, or a business’s deployment of a business intelligence (BI) solution. The insights you get out of a BI system will be less than optimal if your metrics are not well defined.

Whatever KPIs are selected – and they will differ from sector to sector – they must reflect an organisation’s goals. In addition they must be critical to achieving success, and they must also be quantifiable and measurable. KPIs are usually long-term considerations. Their definition and measurement techniques should not change often, if at all, however the goals for a particular KPI may well change as the organisation’s goals change, or as goals move closer to being achieved.

There are typically two types of key performance indicators:

Lagging indicators – These measures are typically financial in nature, and represent the outcomes of past actions. In short they paint a picture of historical performance. Typical examples of these types of indicators include revenue, cost or margin.

Leading indicators – This is where the challenge begins, as in order to determine these predictive indicators, organisations have to look inward and make some difficult decisions. Leading KPIs will tell us how the organisation is performing today. In addition they will predict likely future financial performance, enabling far more effective utilisation of resources, better planning to drive greater efficiency, and prevent surprises in monthly accounts.

Examples of beneficial leading indicators include the number of returns, full on-time delivery and market share.

Organisations often do not define or track these leading indicators effectively, although they can serve as a crystal ball in determining future financial performance.

Success factors
Prior to establishing the measures and undertaking the key steps necessary to ensure that they meet the needs of the business, it is important to understand the critical success factors which lead to appropriate – and killer – KPIs.

Organisational goals – It is vital to establish KPIs based on individual business goals, as opposed to perceived standard goals for an industry. For example, a company that aims to be most profitable will have different KPIs than a company that has a goal of increasing customer retention by 50 percent. The first company will have KPIs related to finance and profit and loss, while the second will focus on customer satisfaction and response time.

Measurement purpose – It is important to analyse KPIs over time, allowing you to make changes to improve performance – then periodically re-evaluate performance to verify progress. For this reason, KPIs must be measurable. The goal of simply increasing customer retention is useless because there is no quantifiable goal, whereas increasing customer retention by 50 percent has a definite quantity that can be tracked.

Goal continuity – KPIs are long-term considerations designed to help with strategic planning. While it is necessary to have targeted goals, they should be incremental to an overall success. Simply because something is measurable does not mean that it is significant enough to be a KPI. You must define your KPIs and keep their measure the same from year to year. Not that you can’t adjust your goals, but you should use the same unit to measure those goals.

Consensus – It is important to have all stakeholders on the same page because personnel from different functions within your company will help create each KPI. If your KPIs truly reflect your organisational goals then it is necessary for all levels of your company to be involved. Encourage company unity and enthusiasm for the project and make sure that everyone knows what the KPIs are.

Set-up considerations
So what are the critical steps in establishing relevant, critical and appropriate KPIs?

1. Map core business processes – Before KPIs can drive business performance a clear picture of what is critical for the business is required- the core processes that drive competitive advantage and sustainable business growth. Developing flow-charts of the major steps in generating revenue will provide a clarity of those fundamentals that should be measured.

2. Establish roles, responsibilities and critical success factors – It is vital that ownership is established for each step within each core process. Without determining who is responsible it is impossible to allocate accountability, and from there determine the appropriate performance indicator, and associate a tangible measure. Once accountabilities are determined, consideration must be given to what each person must do in their role to ensure the business achieves its goals. It is flawed thinking to assume that an individual, or group, has the appropriate skills or tools to meet a measure.

3. Choose the basis of the KPI – This may lead to the identification of a number of critical factors that must be addressed to ensure that each role is completed successfully. Consider the fundamentals of the role and the activities which truly make a difference. Ideally there should be a fixed and manageable number of KPIs per role. There are some vital factors that need to be taken into account when selecting KPIs:

• The person in the role must have full control over achieving that KPI.
• There must be hard, objective data. It is vital to set a baseline figure against which future performance can be measured, and any anomalies must be cleared out – for example the impact of a 53-week year, the variability of when Easter falls on the calendar or any promotional activity.

4. Set the KPI – Having completed the analysis outlined above, there should be a limited number of options. Optimise the return on this by only selecting those that are most critical for business success.

5. Set the target and review date – The final step is to set the performance levels. These need to align with business goals but also need to be considered achievable by those who are responsible for delivering them.

For example, a company goal to be the employer of choice might include a KPI of staff turnover rate. After the KPI has been defined as ‘the number of voluntary resignations and terminations for performance, divided by the total number of employees at the beginning of the period’, and a way to measure it has been established, the target must be set. Reducing turnover by five percent per year is a clear target that everyone will understand and will be able to take specific action to accomplish.

Business goals
Once established, the targets need to have review dates. So which KPIs are right for which business? As indicated earlier, the choice of KPIs depends on the business goals as well as who will interpret and act on the data. There are some obvious KPIs, but remember they are best established as percentages or ratios.

Raw numbers mean nothing unless they are put in context. Similarly, KPIs should be measured over time – it is the trend which is critical in identifying the leading indicators, which will flow through to actual business performance. The specific nature of the KPIs selected will determine the appropriateness of the selection.

If an indicator is going to be of any value, there must be a way to accurately define and measure it. A KPI generating more repeat customers is useless without a means to distinguish between new and repeat customers. Likewise, being the most popular company won’t work as a KPI, because there is no way to measure the company’s popularity or compare it to others.

For a KPI of increasing sales, considerations such as whether to measure by units sold, or by dollar value of sales, need to be addressed. In addition, will returns be deducted from sales in the month of the sale or the month of the return? Will sales be recorded for the KPI at list price or at the actual sales price?

Many things are measurable. That does not make them key to an organisation’s success. In selecting KPIs, it is critical to limit them to those factors that are essential to the organisation reaching its goals. It is also important to keep the number of indicators small to keep all attention focused on achieving the same KPIs. That is not to say, for instance, that a company will have only three or four KPIs in total.

Rather there will be three or four KPIs for the company and all the units within it will have three, four, or five KPIs that support the overall company goals, and can be rolled up into them. If a company KPI is increased customer satisfaction, that indicator will be focused differently in different departments.

The manufacturing department may have a KPI of number of units rejected by quality inspection, while the sales department has a KPI of minutes a customer is on hold before a sales rep answers. Success by the sales and manufacturing departments in meeting their respective departmental indicators will help the company meet its overall KPI.

Know the future
In summary, as profit margins for many companies are being squeezed by increased competition, changing customers’ demands, higher costs and disruptive technologies, it becomes increasingly important to divine the future, rather than react to the past. Reactive responses to historic trading activities can inhibit the flexibility required by a company to effectively ride the economic wave – whether this be rising or breaking.

Establishing effective and appropriately targeted KPIs cascaded through an organisation provides the ability to effectively predict future fiscal positions, allows investment decisions to be made from a position of knowledge, and harnesses the might of the organisation as a whole to deliver the best possible outcome.

While KPIs may not make everyone a category killer, they do allow eradication of waste and maximisation of potential. In a period of economic uncertainty and a time of dog-eat-dog trading environments, the integration of KPIs into everyday business operations will put the finger on the trigger. Be armed, or be a target.

ABOUT THE AUTHOR//
Gary Collier is a Director in PriceWaterhouseCoopers’ Performance Improvement team. Gary specialises in providing practical, pragmatic advice to organisations, driving increased profitability and productivity.
Ph 09 355 8329
gary.d.collier@nz.pwc.com