Key Performance Indicators – Tools For Growing Your Business

by Mark Salmon on 22/01/2010

Planning – The Basis Of Business Success

All business owners hear time and again about the necessity for planning – to set objectives for production, for sales and so on, and the reason is obvious; if you do not know what you are wanting to achieve, how will you ever know if you have achieved it, or that you are doing the right things to achieve it?

Hence the need for a business plan.

Part of any business planning process involves identifying the critical success factors for your business – that is, those processes that you absolutely must get right in order to be successful.

These CSFs will be related to such things as:

  • Which processes are most important to the customer?
  • Which processes have the greatest impact on cash flow?
  • Which processes have the greatest impact on return on investment?
  • Which processes directly impact team morale?

But putting the plan in place is only part of the story – if your progress towards your goal is never measured, that is, if these processes are never measured, you will never know whether you are actually getting the critical things right.

So, in order to manage a business towards its objectives, we must put in place a system of business performance management that allows us to gauge whether we are on track with the Critical Success Factors, that is, we need a set of what are known as Key Performance Indicators (KPIs).

Keep your business off the rocks using KPI's
Keep your business off the rocks using KPI’s

What Are Key Performance Indicators?

A KPI is a measure of a business activity used to estimate how a particular process is actually performing.

You may be familiar with some KPIs even though you haven’t thought of them as such. For instance, the value of production output per employee and your gross profit margin both measure some aspect critical to the success of your operations and can be considered as KPIs.

What the figures are will show if you are performing on target, or above, or below expectations.

But KPIs are not always measured in pounds. Many equally critical activities, such as ensuring customer loyalty, can’t be measured just in monetary terms, so there are in fact many non-financial KPIs as well.

For instance:

  • Average debtor days, which relates to cash management and your cash flow situation,
  • The ratio of complaints to the number of items sold, which relates to customer service, and
  • Absentee rate, which is a big indicator of the morale of your team as well as translating as lost production or sales.

In fact, there are hundreds of KPIs that could be used to track your business’ performance. The key to effective KPI use is to identify a small number, (say 6-8), that measure the really critical activities and to watch them like a hawk.

Where Would KPIs Be Used?

KPIs will vary according to the type of business and the vision of the business. These areas however are ones that KPIs typically focus on:

  • Customer satisfaction
  • Product and service performance
  • Financial and marketplace performance
  • Supplier performance
  • Operational efficiency
  • Performance relative to competitors

I’ll quickly run through a few typical KPIs for each of these.

Customer Satisfaction KPIs

  • Percentage of complaints to total orders
  • Percentage of complaints to customers
  • Value of orders complained about to turnover
  • Percentage of orders not delivered on time
  • Percentage of orders failed prior to delivery

Product And Service KPIs

  • Defect rate
  • Percentage of no-damage shipments to all shipments
  • Warranty costs
  • Order processing time

Financial And Marketplace Performance KPIs

  • Average value of sales per new customer
  • Number of customers
  • Percentage of repeat customers
  • Creditor days

Supplier Performance KPIs

  • Frequency of late order receipt
  • Fulfilment accuracy (frequency of returned purchases, ratio of rejects to total items purchased, rejects per shipment received, frequency of wrong items received)
  • Number, value, or average age of open purchase orders
  • Percentage of complaints handled correctly on the first call
  • Order lead time

Operating Efficiency KPIs

  • Orders shipped per operating period
  • Production rate (per person, or per labour hour, or per machine hour)
  • Average production costs per unit
  • Total quantities produced or total hours billed

Performance Relative To Competitors

  • Brand recognition (that is, the percent of potential customers who know of the organisation’s product or service or who think highly of it), which is generally done through surveys
  • Market share
  • Number of channels in which the product is available
  • Number of customers
  • Number of new customers per operating period

The Purpose Of Key Performance Indicators

Since KPIs are the measures of those processes and financial markers that are critical to your company’s success, when they move in the right direction you know you’re on track towards achieving your objectives.

When they move in the wrong direction you know you have an issue to address.

So, primarily, their purpose is to give you the information you need about your business to make the best decisions about how to run it.

But there are some other benefits to implementing a KPI monitoring system also: they provide a mechanism to facilitate team understanding of what is important to the business’ success and ensure that the team keeps them in mind.

For instance, setting up a system for recording customer complaints and the reasons for them immediately focuses attention on improving customer service or production quality.

KPIs also assist in setting short-term targets, so that when working towards the business objectives tasks can be split into smaller, less overwhelming, steps.

Gathering And Using KPI Information

There are several things to keep in mind if you decide to start gathering information about your KPIs:

  • You need to select those that really are useful for decision making purposes
  • You shouldn’t need to put too much time and effort into getting them
  • You need to put a system in place for monitoring them on a regular basis
  • The information needs to get to the right person
  • They should be promoted among team members

Let’s look at each in turn.

KPI Usefulness

This is self explanatory – there is no use in gathering information about some process that has no usefulness for you in deciding what to do about your problem. Critical numbers are those that relate to:

  • Tracking baseline activity for survival such as per person output, number of items sold, revenue per billable hour and so on,
  • Monitoring for weaknesses such as late delivery of components by suppliers, reducing your debt load, decreasing your invoicing error rate, and
  • Providing opportunities to expand, such as improving production time, customer retention, and sales conversion rate.

A good starting point for identifying useless KPIs is to look at the weekly or monthly management information you currently receive – how much of it goes straight in the bin?

KPI Gathering

In the design stage you must establish that the process is measurable and that the benefit the information will provide outweighs the cost of obtaining and maintaining the data.

The person who controls the process generally understands the most efficient and effective way to measure that process. They will have a much better idea in terms of obtaining useful data to demonstrate where issues arise, and motivating the team to achieve the desired results.

KPI Monitoring

For KPIs to be useful in the management process they need to be reviewed and monitored on a regular basis.

How regularly individual KPIs are monitored is dependent on the KPI itself and the process it is measuring. The general rule is that the further down the process level of the organisation, the more focused on specific functional activity, the greater the frequency of the reporting.

The frequency of reporting becomes more evident once a KPI is defined. There is absolutely no point having a KPI reported on daily, when nobody looks at it for 30 days or if there is nothing that can be done to adjust the process anyway.

Still, at the manager level a lot of numbers ought to be checked regularly – sales for the previous day, the backlog of orders or deliveries, how much stock is available and so on. All can provide early warning of developing problems and allow them to be dealt with.

KPI Availability

KPIs need to be available to the right person or people in the organisation.

They shouldn’t sit on the boss’ desktop if they need to be seen by the people in charge of the operation they report on.

And they shouldn’t go for action to team members who have no control over the activity that is being measured. Ensure the person who is expected to operate on the information has been involved in the setting up of the project so you can count on their buy-in, and that they have the authority to make things happen.

KPI Promotion

It can be very useful in promoting company policy and getting buy-in to make sure team members see some of the data that is being gathered. This can be done as a scoreboard, that is a chart, or handout, to the team. It can show the numbers that drive business profitability – sales, COGS, etc.

Some companies even include the team’s bonus evaluation forecast based on the to-date KPI indicators for profit! It can be a pretty good motivator.

Providing the scores and explaining the situation is one way of helping your team move the KPIs in the right direction.

Of course you may need to do some training around this – how many of your team would know what ‘operating efficiency’, ‘turnover’ or ‘gross margin per hour’ mean if you presented them cold as a figure each month? And when they do understand, and do have them available, you can also use them to brainstorm ideas on improving the situation.

Federal Express – An Example

Federal Express illustrates all of these issues.

As part of its vision, Federal Express wanted to be the best in its industry. Therefore one of its critical success factors was to achieve 100% customer satisfaction on each transaction and interaction, and 100% service performance on every package handled (i.e., delivered when and where promised).

So the company applied a 12-point measurement system to track the degree of satisfaction and service performance. This is tracked both daily and for the period-to-date, and reported to team members.

Federal Express measures the results of the activities it performs each day from its customers’ perspective. It set a goal that reflected a critical success factor and installed a set of measures for their performance—their KPIs.

The result – a highly profitable, systematised business, which is renowned globally for its exceptional delivery record.

Interestingly, FedEx took the concept one step further by allowing customers to track their parcel on its journey by providing Internet access to their records.

Opening up access to customer focused KPIs in this way is a terrific example of locking in your customers, AND it also got the team very focused on delivering to agreed performance standards.

Determining The KPIs To Track

Which of the hundreds of potential KPIs for your business do you track?

Some, particularly the financial ratios, are really basic and every business person should know which they are and what they indicate about their business. For instance the ‘acid ratio’, or cash and debtors divided by current liabilities, is generally considered to be a good assessment of your liquidity, which can be vital to keeping your head above water on occasion.

Others have more to do with tracking how well your production is going, or your selling, or how efficient your invoicing procedures are, or how well your suppliers are performing.

Deciding whether or not to set up a KPI monitoring system for these depends on whether or not they are crucial to your success at the moment.

I say ‘at the moment’ because situations can change. If you have found customers complain about team members not knowing anything about the products they are selling you might work on your team training until every team member meets the required KPIs for product knowledge (hours spent using the product themselves etc), and sales service. At that stage you may not need to monitor any longer – presumably as part of the exercise you’ve set up some system for training any new team members as they are taken on.

Strategy Determines KPIs, Not KPIs The Strategy

There’s a very important concept here – we must keep in mind that whatever we do to alter the individual figures in the direction we want has to be looked at from the overall objective.

So if we want to improve our debtor days, it may not be wise to do it by calling the debt collectors out to harass the customers – we could actually damage sales both immediately, and in the longer term, by the damage to our reputation.

If the objective was to build gross sales, the sales team might achieve it through massive discounting. So if one of your KPIs here was ‘number of sales per salesperson’ it might look pretty good. But obviously it’s not a viable strategy and you’d need to have either ruled out discounting as a strategy from the beginning, or maintain KPIs on net margins, gross margins and cost per sale, to ensure it didn’t get out of hand.

The way you choose to improve a critical number, the strategy, has to be consistent with the overall goal.

Let’s look at how KPI monitoring can actually work in practice using Cash Flow as an example

KPIs In Action: Cash Flow

If we look at cash flow as a CSF we can understand how KPIs and strategies fit together.

Cash flow is a CSF for any business because if a business runs out of money it will cease to exist. Hence the processes involved in tracking and maintaining cash flow require measurement through KPIs.

It is important to appreciate that you need to measure both sides of the cash flow equation. If you were to only measure the debtors’ days you may find that we have wonderful KPIs in that people are paying quickly, however you may be losing customers because of your aggressive collection policies.

Measuring both sides of the equation allow us to come up with a happy medium and ensure that your team understand that you are not prepared to have debtors days decrease at the expense of our customers, that is, at the expense of an overall goal of maintaining or increasing customer numbers.

Cash Flow CSF – A Sub-System Of KPIs

Let’s take another factor affecting cash flow – gross sales. We may not be able to pinpoint exactly where we need to focus our corrective action if we are unsure of why the gross sales has dipped. If however we look at sub-system KPIs (i.e. those that affect gross sales) we have a better opportunity to identify the real issue.

Generally sales are made by obtaining sales leads, and converting those to actual sales. If we look then at the sub-system KPIs i.e. the leads generated and the leads converted, we can quickly see what area to concentrate on.

These sub-system KPIs have the added benefit of identifying bottlenecks or process weaknesses. We are then able to take action based on whether we need to address our advertising and marketing to generate leads, or whether or not it is our sales process and methods that need work.

We can then also decide if we require additional information and what type of additional information is required in order to make an even more informed decision.

Say for example that the conversion rates were dropping, we may then need to dig further into differences in sales people’s conversion rates or even look at seasonal comparatives.

If we are routinely keeping this type of information we are able to react much faster. If we were not tracking these areas there could potentially be a long time lapse in taking corrective action.

Summary

The establishment of KPIs is just one part of a process of business performance management.

Performance management needs to incorporate the analysis of results as well as the planning and managing of the business strategy and vision. The use of KPIs is the critical first step that facilitates the entire process of business performance management.

What you can measure you can manage.

There is no point in reporting KPIs if the dust settles on the report before action is taken. You need to ensure you have a system in place to take action on your KPIs. That is where the benefit lies in implementing Key Performance Indicators.

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