Friday, November 11, 2011

Three fundamentals of KPIs

Measuring performance seems complex (and it is) but let's not lose sight of the basics. The trick with key performance indicators (KPIs) comes down to three questions:
  • What is KEY? What are the long term objectives of the enterprise?
  • What is PERFORMANCE? What results do you aim for, what is success, what is failure, what are the acceptable ranges? 
  • What are INDICATORS? What metrics define desired performance, at reasonable cost? 
What do you really care about? You could apply this question to your personal preferences in life but what we are talking about here is what is important to your organization.  Organizations don't have a single identity so often you're trying to amalgamate a variety of disparate views, values and opinions. Certainly, you can be guided by policy statements, organizational objectives and strategy documents, and they are probably the first place to start looking for answers. In the end however, someone needs to be accountable to define what is actually 'important'.  Depending on the scope of your study, this could be the CEO, the budgetholder, Chairman of the Board or simply the line manager responsible for that specific area.

Here are a few questions that might guide your investigations when establishing what is 'key':

  • What is the scope of this KPI?  The whole organization? A small project? My workgroup?
  • What couldn't the organization survive without? You could take a 'red team' approach to this by getting a team together to ask "How would I attack or cause this organization to fail?"
  • What are we trying to achieve here? Ie. What are the objectives of this organization/group/project?

As the adage goes "what gets measured, gets managed".  It's essential to have some simple and clearly defined view of what performance means.  That means you either need to ask binary questions (Eg: Is our gross profit greater or less than 10% of turnover?) or measure it quantitatively (Eg: What is our nett profit?). 

In some cases, you might also choose to use some semi-quantitative questions. These aren't quite as good as pure quantitative data but can at least provide some sort of ordinal measure (Eg: Is the organization improving our score each year?).  A simple example of a semiquantitative score can be found in the figure below. This simple example looks at converting some simple 'word pictures' into an ordinal scale. One of the limitations of this scale is that it's primarily subjective. That doesn't mean that it's not useful however. If you can think of 10 or more areas to measure, and are rigorous with developing the criteria for each of the four grades, you'll end up with a fairly good idea as to where your weaknesses are and whether or not the organizations performance is increasing over time.
Figure 1: Example of a Semi-Quantitative Scale

Here are a few questions that might guide your investigations when establishing how to measure 'performance':

  • What is the timeframe that I'm interested in?
  • What would we consider as catastrophically bad?
  • What would we like to be able to report to the Board/boss/shareholders? 
  • Would data would we need?
  • What information/data/statistics do we already have?
  • How much would it cost to get ALL the data that we'd need and how would we go about acquiring it?


What are the metrics that can help us measure our performance? This question above all others is entirely dependent on context. An insurance company might have a wealth of data about it's clients risks but if it is developing KPIs for financial performance

Here are a few questions that might help with developing 'Indicators'':

  • Would data would we already have?
  • What information would would we like that we don't already?
  • How much would it cost to get all the data that we'd need and how would we go about acquiring it?
  • Are there industry standards or legislated reporting requirements that we can piggyback on?
  • What compliance framework do we already have?
  • What systems (accounting, safety, incident reporting, sales, etc) do we have in place? How could I modify or integrate those systems to get a better result?
  • Which are lead and which are lag indicators?

Keep at it. Ask lots of people for help, input and go with the simple questions. What's important to you? How would you measure it? What information would help you understand your business? Once you can get to these answers, (which is every bit as hard as it sounds) you have the exact set of KPI's your organization needs. More is waste, less is mismanagement.

1 comment:

  1. Hi

    You have written a good article and you make a lot of sense. What is missing from the article, possibly only because it was out of scope, is the additional question of:

    how are you going to respond to a KPI that is flagging attention.

    This does seem obvious I know, but in my travels I find scores of examples where management teams have great scorecards but take to tactical or strategic action to address KPIs that are demanding action.

    This is often because the KPI is scoring actuals without reference to a plan. Example, sales are trending down. This is easy to explain. Its the GFC. Another indicator is production. Inventory is climbing. Easy to explain, Sales are down.
    But when you start to put them together and draw out some ratios and say that inventory can never be more than 1.5: 1 of sales, then when you look at your KPIs, you may not be so quick to rest on the above mentioned explanations. They are both accurate,and individually not overally a big issue, but collectively it means you are rapidally going out of business.