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Key Performance Indicators
One of the keys to effective financial management is to regularly monitor the "critical factors" that determine the success of your business. Financial statements aren't great for this purpose because they can be complicated and time-consuming to prepare. Instead, what most companies need is a short list of key measures that they can look at on a regular basis (weekly or monthly) to see how the business is tracking. The way that many successful companies do this is through Key Performance Indicators (or KPIs for short).
What are KPIs?
KPIs are quick measures of your business' overall health and well-being. They focus on aspects of your company's performance that are vital to ongoing and future success. In essence, KPIs work like a report card to tell how the business is performing in crucial areas. As a result, they allow you to 1) quickly get a clear picture of what's happening with the business and 2) get an early read on trends and future profitability (i.e. while there's still time to take action that will influence the outcome).
Examples of KPIs
KPIs vary greatly by company and industry. For example, big retailers (like Starbucks and WalMart) regularly track "same store sales growth" as a measure of overall sales performance. A company like Proctor & Gamble might monitor "revenue and/or gross margin by product line" to track the performance of its different products and divisions. A company like FedEx might track "average delivery time" to monitor its overall efficiency. Other examples of widely-used KPIs include things like: revenue/expense ratio, average age of receivables, total order shipped, days inventory on hand, marketing expense as % of sales, etc.
Five Steps for Developing KPIs
Following is an overview of the basic steps involved in creating and implementing a basic set of KPIs for your company:
Step one: communicate the purpose of KPIs within the organization.
Realistically speaking, KPIs that are not owned and accepted by the workforce will not succeed. In order for KPIs to be successful, you must first work on creating the right internal environment and getting buy-in from key stakeholders (employees, managers, customers, etc.) These are the people who will be the ultimate drivers of the project's success.
One of the biggest challenges that companies face in developing KPIs is overcoming team members' fears and uncertainties. Most employees hold a long-standing suspicion of management-led forays into performance improvement (i.e. "Why are they doing this?" "Will the information be used against me?"). The best way to eliminate these fears is to explain the rationale for KPIs at the outset and include everybody in the process. When this is done openly and clearly, then all employees should at least believe that "we need to start doing things differently" and a core group of them should be very clear about what KPIs involve and how they will be used.
Step two: identify the "critical success factors" for your company.
These are the key areas in which things must go right in order for the company to remain competitive and succeed. Sometimes these factors are mentioned in the company's business or strategic planning documents. Other times they haven't been written down but the owners have an intuitive feel for what they are. Generally speaking, critical success factors come from one or more of the four broad areas that determine success for any organization: customer focus, financial performance, people, and innovation.
Tip
Most companies try to begin the KPI process by identifying critical success factors. However, the best time to start building trust about the use of KPIs is at the initiation stage- that is, the first time the idea is raised within the organization. Therefore, we can't emphasize enough the importance of undertaking step one (communication) before step two in order to maximize the chance of success.
Step three: select and develop KPIs.
Once the critical success factors have been determined, the next step is to start defining and selecting KPIs. If the CSFs are clearly defined, then it is a fairly straightforward process to generate ideas for KPIs. Key employees are actively involved in this process and the work is often done in teams. In fact, major KPI breakthroughs usually do not come from management but from local teams and workgroups themselves (from the factory floor, so to speak). Management's primary role is to provide the leadership and drive required to develop KPIs, and then provide the support and assistance needed to implement them.
Tips
1) Focus on practicality, not perfection. Encourage teams to pursue KPIs that provide valuable information but do not require inordinate resources to collect.
2) Look for leading vs. lagging indicators. Lagging indicators reflect things that have already happened (i.e. sales). Leading indicators are helpful in predicting future results (i.e. product quality, customer satisfaction). Leading indicators give management and employees the opportunity to act quickly when results aren't being achieved and, as a result, impact the organization's overall performance.
3) Work with a limited, manageable number of KPIs. Most companies need only a few measures, in no case more than a dozen. Too many KPIs makes it difficult to focus.
4) Persistence pays off. Virtually no team will achieve a perfect set of KPIs on its first or even second attempt. Keep experimenting and you're bound to succeed.
Step four: implement the KPIs.
Once KPIs have been developed and people within the organization are involved in the process, the next step is to implement a system that regularly tracks and reports the information to key individuals (for example, the business owner). In many cases, implementing a KPI involves two people: an employee in the department where the activity is being measured (ex. manufacturing, sales, customer service) will be given responsibility for gathering the data, and the manager of that department will be given responsibility for achieving the target and reporting results to the owner. Some types of data (i.e. operational data) may be collected weekly or monthly from the company's computer system. Other types of data (i.e. information about customers' satisfaction with the organization) may only be collected annually through a survey. Some other useful methods for collecting data include checklists (i.e. to analyze results over a period of time), visual inspections (i.e. for quality), and focus groups.
Step five: monitor results and make improvements (i.e. take action).
In many respects, step five is the most obvious and the easiest to complete. The important thing is to monitor your KPIs regularly and compare them to past performance and established targets. If the desired results aren't being achieved, then management must discuss what action to take. Potential actions might include: taking a closer look at the problem area, revising the target, making operational corrections, or changing the company's strategy.
Conclusion
It is important to point out that the real goal of building a KPI system is not just to provide a short list of indicators that shows what's happening with the business. Don't get me wrong, that's a wonderful thing. However, the greatest value of KPIs is that they can help you create a culture of continuous improvement and teamwork within your company. KPIs provide an opportunity to keep everybody (management, employees, suppliers) focused on what needs to be done in order to improve performance and keep the business on course. When teams understand where management wants the company to go, and how their job fits into the overall plan, they are enlightened and empowered to help the company achieve its objectives. And as most leaders of successful companies know, people are far and away the most important drivers of your business' success. (Source: Principa)
Posted by
at 11:02 PM November 2, 2005
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