Key Performance Indicators (KPIs)

Critical indicators of the firm's success

Key performance indicators (KPIs) are critical indicators of the firm's success. Specific and measurable goals must be achieved for the firm's strategy to succeed.

Indicators can be financial and non-financial. Vital for gaining a sustainable competitive advantage. It aids managers in learning the importance of financial and non-financial indicators of success.

1. Peter Drucker, Father Of Modern Management, defines what Key Performance Indicators are in essence.

"You can't control what you can't measure."

Macmillan's Dictionary defines them as,

"A way of measuring the effectiveness of an organization and its progress towards achieving its goals."

Kaplan/Norton, Creators of the Balanced Scorecard.

If you can't measure it, you can't manage it."

Indicators are of two types, based on Hierarchy.

  1. High Level- for Organizations,  
  2. Low Level- for Departments/Functions.

They are criteria for the advancement towards the intended goal:

  • Provide focus on strategic and operational improvement.
  • Generate a logical base for decision-making.
  • Aid in being attentive to what matters the most.

KPIs are the tools organizations use to achieve the intended performance.

Key Performance Indicators and The Balanced Scorecard (BSC)

Balanced Scorecards (BSC) 

A strategic measurement and management system provides organizations with simple tools that show specific financial and non-financial indicators of success. 

It translates the company's strategy into four balanced categories.

  • Financial.
  • Customer.
  • Internal business process.
  • Learning & Growth.

BSC aims to:

  1. Focus on financial information and indicators.
  2. Create and develop abilities.
  3. Add intangible assets required for long-term growth.

Balanced Scorecard: It considers financial indicators to be lagging indicators. Each of these categories (perspectives) has four dimensions.

  1. Objectives.
  2. Measures.
  3. Targets.
  4. Initiatives.

Measures=KPIs. In simple words, these indicators are a tool of the BSC.

Key performance indicators under BSC aids in developing strategy. It encourages the person responsible for analyzing an organization's internal strengths and weaknesses and external opportunities and threats.

These combined efforts are known as SWOT Analysis.

  1. Strengths (s): core competencies of an organization.
  2. Weakness (w): Areas where an organization is at a disadvantage.
  3. Opportunities (o): Chances to generate profits and cash.
  4. Threats (t): Elements in the external/internal environment threaten the organization's objectives.

Performance indicators (PIs) are measurement units assigned to each subject. Developing PIs lead to several conflicts, which BSC minimizes by integrating PIs into firms' strategy.

Once the indicator measurements are defined, they must be linked back to the firm's strategy. Here is a detailed paper on the Balanced Scorecard

Why are KPIs important?

It is a strategic management tool that provides a view of an organization's success in financial and non-financial, accepting that real growth and prosperity lie outside the framework. 

KPIs:

  • Are more than numbers.
  • Aids in understanding and monitoring business performances.
  • Helps in identifying the areas for improvement.
  • Successful implementation leads to best execution, resulting in achieving strategic goals.
  • Assists in analyzing patterns over time.
  • Solves problems and tackles them.
  • Identifies opportunities.

Financial measures are objective, subjective, quantitative, and historical. Therefore, they are better for short-term forecasts than long-term predictions.

Companies want to focus on leading indicators of future success.Customer satisfaction leads to customers coming back for the service provided. In addition, a decrease in defects ensures an improved process and fewer resources expensed in rework.

Characteristics and Need for Good KPIs

Some of the characteristics are:

  • Yields quantifiable progress results in the achievement of an organization's goals and objectives.
  • Assists in better decision-making.
  • Offers a view of comparison.

Also, KPIs are essential to any firm because they track and monitor the following aspects: 

  • Effectiveness, efficiency, and adaptability.
  • Growth, quality, and timeliness.
  • Personnel and organizational performance.
  • Resource use.

They must be specific, measurable, achievable, reliable, realistic, and timely. Some of their goals are the outcomes the organization wants to achieve are encouraged by measurable metrics.

Performance indicators demonstrate whether/if the organization is on track. A clear distinction is necessary on the whole.

The confusion increases when goals and KPIs terms are used in place of each other. Where one term is specific, measurable, and accurate, the other is a bland statement/target.

Pattern Analysis

Weekly, monthly, quarterly, and annual PI Reports ease exposing a pattern. Identifying months and quarters with slow growth rates can enhance business strategies.

Aids In Decision Making

The need to apply systems, and integrate processes, aiding in the decision-making process from the business intelligence gained.

Accountability

When the targets and measures are set in quantifiable terms & metrics, numbers don't lie. The difference from the targets will point towards the department or personnel responsible.

Transparency

When the targets aren't known, the actions aren't quantified and directed towards them. There could be no latitude of improvement in a system where you can't gauge performance.

Targets and measures are identified, and causes and effects are in knowledge. Individuals/teams are better informed on where to focus their energies and expertise.

Target Measurement

Indicators can point out the amount/proportion of goals achieved, where goals are objectives that are the level of performance desired. In this way, the supervisor is knowledgeable about, 

  • Progress
  • Reasons for failure
  • Identify gaps
  • Enlightened about the steps required

The list is not exhaustive. The Needs of Performance Indicators may differ on the nature and activities of the organizations involved and what the corporation wants to achieve.

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How to Develop KPIs? 

Understanding Your Strategy

A clear and apt understanding of the Organization's Strategy is a must to set PIs most beneficial.

Objectives must be set in alignment with the strategy, contributing toward the result-oriented approach. Activities and plans lead to the implementation, implementation signifies improvement, and these improvements are measured.

Identifying & Selecting Performance Indicators based on strategy

Once the strategy set is clear, the success factors should be clear. The performance indicators may vary across the organizations and industries. Performance indicators can be of 2 types:

  • Lagging indicators/outcome measures: Measure the current and past performances. Only known after an event has already occurred. It confirms and clarifies the pattern and trends over time.
  • Historic in nature: Example: Profitability, market share, employee skills, etc.
  • Leading indicators/performance drivers: Indicators that might predict future favorable outcomes. They are indicators and drivers specific to the strategy of the business unit. Example: Cycle times, setup times, patents, etc.

Get Buy-In

Unquestioned support and dedication of employees towards the indicators will provide assurance. This ensures loyalty. Stakeholders' support will ensure the financial support coming in. This ensures confidence in the management.

Deploying Measurable Goals

  • Indicators identified and selected,
  • plus the support and confidence of employees
  • along with stakeholders, now it's time to implement the performance measures.

These measurable goals should be on accurate data and owned with the right responsibility.

Variance Analysis

As the indicators are quantitative, they can be analyzed for non-achievement. 

Interpret Results

Favorable results are indicators moving towards their targets, even exceeding them. Unfavorable results are the ones moving away from the targets.

But, the key is to see the variation between the normal and the abnormal ones.

  • Consideration of Patterns and Trends.
  • Looking for ways to change and not control the outcomes.
  • The user must be ready for a lot of questions instead of answers.
  • Taking a deep dive into the source of information and data.

Take Action

When moving in an unfavorable direction, indicators are likely managed and monitored over time. Two types of actions are available but aren't limited to, 

Remedial Activity: Actions taken under normal conditions in the absence of an anomaly. It should be clear, associated with the indicator, and assign an individual for it. 

Strategic initiatives: Activities causing organizational changes are complex.

The list of steps and priorities while developing key performance Indicators vary between companies and industries. Also, it depends upon the professional/author's views and goals.Here is Bernard Marr's take on Effectively Developing Key Performance Indicators.

Implementation Of KPIs

Develop Key Performance Indicators

A thorough examination and data review are essential once the indicators are in place. The distinction between the indicators and metrics is imperative.

Prioritizing

Separation of operational measurements from strategic ones. Operational measurements are more active and real-time indicators. Example: per hour or per-day basis measures.

Strategic elements go for the long run. They take a longer view at monitoring the progress towards the stated goal.

Analyzing

Performance indicators are as useful as utilized. "Tracking" these indicators won't make any difference. For them to be beneficial, interpretation is a must. The use of lagging and leading indicators aids in prioritizing and analyzing the indicators.

Establishing Actions with Results

Aligning results with actions facilitates an organization in:

  • Measure the health of the business
  • Predict outcomes
  • Steps leading to the right outcomes
  • Identification of practices used and changes is a must 

Application of key performance indicators will boost organizations' business/financial health and efficiencies. Their implementation may also minimize inefficiencies and bottlenecks.

What are the benefits of Key Performance Indicators (KPIs)?

Future Strategies

It is tracking the progress from day 1 of its implementation. Any deviation from the goal or any leads is accounted for. Feedback could be given to set the ship to sail in a direction fruitful. 

In the development stage of indicators, the strengths, weaknesses, opportunities, and threats are carefully analyzed, with the help of which strategies are formed. 

With favorable actions towards achieving the organizational goals and objectives, strengths may become formidable traits. Weaknesses will be minimized, opportunities will be cashed, and threats will be averted through the most acceptable risk management policy.

Close Learning Gaps

The learning & growth perspective focuses on the employees and their satisfaction. This also helps them in their professional development. This may include encouraging employees to take courses contributing to their position, enrollment in certification courses, and continued professional education.

Empower employees to take action towards the achievements of targets set. Aligning an employee's work efficiency with performance evaluation will allow the supervisors to judge actual performance against the expected performance. 

Alignment with organizational goals and objectives can be assured by attaching an employee's performance with performance evaluation metrics. Incentives, salary hikes, and promotions should be awarded based on favorable performances. 

Deduction in salaries, penalties, and demotions in case of unfavorable performances.This mechanism encourages the employees to work for the organization's goals and align their activities with the management.

Rewards

Supervisors and managers head the performance reviews. Employees are rewarded for their contributions. KPIs help in setting targets, actions taken, and reaching those targets. Achievement of targets should be rewarded accordingly.

Measure outcomes and results

The sole purpose of the performance indicators is to check progress. Results are displayed in the form of metrics, amounts, or data. Measuring the outcomes also facilitates understanding of whether the organization is on track to achieving its targets and goals.

They can be compared with the standard performances set in times of adverse results.

What are the Disadvantages of Key Performance Indicators (KPIs)?

Time-consuming

Once implemented, the indicators should be subject to evaluation and monitoring. And, to witness fruits, especially from the non-financial perspective, might be time-consuming.

Example: You may have implemented an employee training program. Checking the benefits and the learning of employees will be challenging to quantify.

High Learning Curve 

In the initial stages, it's better to stick to one or two PIs. Although there could be more than two performance indicators for one subject, the increased number of PIs will cause confusion and hassle.

Data Collection

Before developing performance indicators, information for building accurate and stable PIs is collected. The process, along with being time-consuming, is energy consuming, too, given the resources engaged in collecting the data.

Integration With Strategy

The indicators must be built-in in alignment and integration with the firm's strategy. These indicators may differ among the industries and operations, and they must be selected with the utmost attention.

How to Interpret KPIs?

It is also essential to set achievable goals. KPIs are about focused data, not setting ambitious targets that can skew performance away from cohesive strategies.

There's a need to define your goals, where you might need to increase efficiency. With concrete and reliable research, they may yield insightful results. Yet, this may be time-consuming.

Philosophy, strategy, and operations will determine the indicators:

  • Selection
  • Use
  • Interpretation

Sales/Finance Driven Company may use indicators following:

  • Revenue
  • Net Profit
  • Gross Profit
  • Revenue Growth Rate
  • Sales in Quarters
  • Sales Returns 

NOTE

Not all measures with an upward trend are favorable.

Ex: The percentage of sales return increases. The unit/dollar sales are coming back.

Interpretation: Unfavorable

Customer-Centric Company

  • Customer Satisfaction Index
  • Customer Retention Rate
  • Customer Profitable Rate
  • Customer Complaints

Ex: Increasing customer complaints is not ideal.

IBP

  • Cycle Time
  • Order Fulfillment
  • Rework Level
  • No. Of Defects.

Ex: Increase in the number of defects points toward an inefficient business process.

L&G

  • Employee Satisfaction Index.
  • Revenue Per Employee.
  • Salary Competitiveness.
  • Employee Turnover.
  • Reducing resources spent on training and hiring new employees.

Problem with Performance Indicators

Threshold Setting

KPIs will have a 'favorable' margin for good performance, set somewhere at or below 100%, giving a tolerance for error. Any PI that fails the threshold(s) scored 'red,' if passes, 'green.'

For example, employees A, B, and C are being evaluated on the same indicators. A, B, and C's scores are 92 and 94. C scores 97. If the threshold for A and B were set at 90 and 95, the result would be "Favorable."

The threshold for C, which stood at 98, was "unfavorable." Although C's score was the strongest, it's considered an "unacceptable" cus of the threshold.

  • Slack PI: Set lower than expected
  • Strict PI: Higher than expected

Benchmarking Performance Indicators

Departments R, S, and T are working on similar projects with the return on investment (ROI) indicator. Let us add the market average for the project as a benchmark.

Example

R's ROI= 12.2%

S's ROI = 14.5%

T's ROI = 16.1%

Benchmark stands at 14%, and S and T are doing good since they are above Market Average.

If R sets its indicator at 11% in the Performance Review, it is "Favorable."But, not good enough if compared to the Market Benchmark.

Organizational And Departmental PIs

Organizations use performance indicators at many levels to test their success in reaching targets. High-level indicators focus on the overall performance of the business. In contrast, lower-level KPIs focus on processes in departments and functions.

At the organizational level, analysts start in theory from:

  • The firm's objectives
  • How they are to achieve
  • What to do in times of failure
  • Personnel responsible

A clear distinction between these indicators is valuable since they relate to different levels of the firm. Communication and setting up the importance of these indicators are of equal worth.

The list of challenges and problems isn't limited to the list above. Here are some more challenges faced by organizations.

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Researched and authored by Farooq Azam Khan | LinkedIn 

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