What is a KPI?
In the development and management of a business, key performance indicators or KPIs are critical to understanding performance and decision making. Although KPIs are used by almost all parts of a business, they are often poorly understood and their true potential unrealized. KPIs are defined as quantifiable or qualitative measures which enable organizations to gauge their effectiveness in achieving strategic and operational goals . They are used by managers and executives to evaluate the performance of the business and determine whether they are adhering to the strategic plan . These key performance indicators are commonly part of an actionable scorecard which enables organizations to make informed decisions to keep their strategy on course. KPIs vary and may be based on standards specific to a particular industry. However, setting indicators only on the basis of industry standards without considering business needs can lead to failure. What follows is the first installment in a two-part series explaining how to create relevant, impactful indicators and maximize their effectiveness.
Steps to creating KPIs
KPIs are those which allow for the monitoring and controlling of operations that have a huge impact on the bottom-line of the business. The focus is on critical activities within the organization tied to this essential point.
When creating KPIs, the following should be considered :
- Number of KPIs to be formulated
- Frequency of measuring KPIs
- Whether or not there is need for KPIs at all levels of the organization
- Targets to be set for the identified KPIs
- KPIs manageability and controllability
- Differentiating departmental from enterprise-wide KPIs
- Infrastructure to support the formulated KPIs
- Identifying the purpose of establishing each KPI
All the aforementioned points should be addressed in detail for creating insightful and effective indicators.
Step 1: Number of KPIs required
The first question that arises for managers and executives is how many KPIs are required to meet the goals of the business. Many managers believe that more is better and will take an all-encompassing approach of building as many indicators as they can . However, this can lead to bulkiness in the measuring process and make it difficult for managers to “dig out” what they need to know at a given time. It sometimes obscures the linkages between cause and effect thereby complicating decision making rather than simplifying it. Key performance indicators should be set only for critical activities. It is recommended to break KPIs into parts or categories such as cost, quality, delivery, safety, etc. These categories should be dependent on the need and nature of the business. For each part or category, a maximum of three KPIs should be created .
Step 2: Frequency for measuring KPIs
To evaluate the performance of indicators such as customer satisfaction, the business must regularly monitor them. This monitoring is essential to determining whether objectives can be met. Such monitoring is performed by putting the requisite data onto a dashboard. For example, if the level of customer satisfaction is less than its target, then a red signal icon can be programmed to be displayed on the dashboard . The period of measuring indicators, which are usually determined by management, can be daily, monthly, quarterly, or annually. However, in recent years, it has become commonplace for executives to demand KPIs up to an hour or less in frequency. Measuring daily can help management improve performance around teams and work culture. However, such daily trends can be very volatile. True process improvement may not be visible for weeks or months afterwards. In such cases daily measurements will be ineffectual. Also, daily measurement can make employees too focused on short term objectives. It is essential for the organization to set a period and frequency of measuring KPIs that make sense. Below are descriptions of the three types of periods commonly used for monitoring performance :
- Closed Periods – Preparing results after the end of a specified period. These periods are generally used for reporting to the shareholders or financial reporting.
- Open Periods – Year-to-date reporting. These are generally easy to understand, but not suitable for comparison with earlier periods.
- Moving Periods – These are defined as small measurement periods. These are best for performance measurement because they are less volatile and provide a good trend. They are usually measured either monthly or quarterly.
Step 3: Need for KPIs at all levels
Employees are often held accountable to meeting various targets set by senior management of the organization. As a result, the regular work performed by employees needs to be in alignment with organizational goals. To this end, performance indicators are often needed at the individual and team levels as well as the organization . Although it is recommended that organizations set KPIs to evaluate performance on the whole, managers and team leaders must also establish KPIs within their respective areas. This is because the overall performance of the organization will improve only if the performance of the employees at lower levels of the organization improves. Additionally, KPIs at the group or team level will often roll up to the organizational level. This ensures that everyone is working towards the organization’s strategic plan.
Step 4: Setting targets for the identified KPIs
A challenge for management of any organization is identifying areas for improvement and setting appropriate and achievable targets for them. This is difficult because targets are not always quantifiable. One way around this quandary is to break larger KPIs down into smaller, more digestible, and more easily quantifiable ones . The targets must be closely linked to the top-level objectives and goals of the business . They should be realistic yet challenging enough to “stretch the organization” to ensure growth.
Step 5: KPIs must be manageable and controllable
KPIs should avoid measuring environmental factors or other aspects outside the control of the company. For example, there’s nothing we can do about the past. That is why KPIs should be current or predictive in nature and not focus only on past performance. The organization must always set targets for which the company has some level of control. For example, sales which are seasonal in nature should not be set as a KPI because the controlling factor is time and not the efforts involved in selling the product. Another example that can be taken in this context is the rate of interest for a bank loan. The interest rate should never be used as a KPI because it is not under the control of the organization.
Step 6: Establishing differences between Enterprise and Departmental KPIs
In medium and large-scale organizations, there are typically several departments. Having KPIs only at the organizational level may not prove completely beneficial. If organizational targets are not met, it would be difficult for management to identify the departments that are responsible and resolve bottlenecks. However, such KPIs and their targets must be in line with enterprise KPIs to guarantee simultaneous accomplishment at all levels. For smaller organizations having departmental KPIs may not be necessary.
Step 7: Proper infrastructure to support the formulated KPIs
Today, the ability to create large volumes of data has exceeded our ability to make sense of it all. Large staffs are often deployed for creating data and generating reports while little effort is focused on deriving consequential information from it. It is important for any organization to take into consideration the investment made in resources and infrastructure to support KPIs. More is not always better. Just as we ensure that KPI development is tied to the critical activities of the business that affect the bottom line, so should it be for the infrastructure supporting it. If the investment in infrastructure outweighs its benefit, then the whole purpose of having KPIs is compromised.
Step 8: Identifying the purpose of establishing KPIs
Every business must evaluate and judge its own performance to be successful. This is critical for process improvement, organizational effectiveness, and ensuring profitability. Managers should work to identify areas of improvement according to the needs of the business. Before formulating any KPIs, an organization must conduct due diligence to identify a need and purpose for each indicator and understand what part it plays in the strategic plan for the company .
Setting targets for performance helps the business achieve its strategic objectives in addition to facing challenges and carrying on day-to-day activities. Although KPIs are often quantitative due to the ease of measurement, qualitative indicators have proven equally effective in unique contexts. In short, performance measurement is a must for every business. Now that we have discussed the mechanics of creating key performance indicators, in our next installment we will discuss key characteristics for building “killer” KPIs that can provide competitive advantage.
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Dr. David A. Bishop
Principal, Agile Worx, LLC
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