There's
a lot of talk these days about key performance indicators
(KPIs). They are the backbone of scorecards and dashboards
which have become an irresistible way for organizations to
present performance information to executives and staff. Unfortunately,
BI developers seems to focus more on creating visual metaphors
(i.e. dial, gauges, arrows, etc.) than understanding what
constitutes a good KPI that delivers long-term value to the
organization.
Part
of the problem is that people use the terms "KPI" and "metric"
interchangeably. This is wrong. A KPI is a metric, but a metric
is not always a KPI. The key difference is that KPIs always
reflect strategic value drivers whereas metrics may represent
the measurement of any business activity.
When
developing KPIs for scorecards or dashboards, you should keep
in mind that KPIs possess ten distinct characteristics. Although
metrics may exhibit some of these characteristics, good KPIs
possess all of them.
#1.
KPIs Reflect Strategic Value Drivers
KPIs
reflect and measure key drivers of business value. Value drivers
represent activities that when executed properly guarantee
future success. Value drivers move the organization in the
right direction to achieve its stated financial and organizational
goals. Examples of value drivers might be "high customer satisfaction"
or "excellent product quality."
In
most cases, KPIs are not financial metrics. Rather, KPIs reflect
how well the organization is doing in areas that most impact
financial measures valued by shareholders, such as profitability
and revenues. As such KPIs are "leading" not "lagging" indicators
of financial performance. In contrast, most financial metrics
(especially those found in monthly or annual reports) are
lagging indicators of performance.
#2.
KPIs Are Defined By "Executives"
Executives
define value drivers in planning sessions which determine
the short- and long-term strategic direction of the organization.
To get the most from these value drivers, executives need
to define how they want to measure their organization's performance
against these drivers. Unfortunately, too many executives
terminate strategic planning sessions before they define and
validate these measurements, otherwise known as KPIs. The
results are predictable, giving proof to the adage, "You can't
manage what you don't measure."
#3.
KPIs Cascade Throughout An Organization
Every
group at every level in every organization is managed by an
"executive" whether or not the person carries that title.
These executives may be known as "divisional presidents,"
"managers," "directors," or "supervisors," among other things.
Like the CXOs, these "executives" also need to conduct strategic
planning sessions that identify the key value drivers, goals,
and plans for the group. At lower levels, these elements may
be largely defined and handed down by a group higher in the
hierarchy.
However,
in every case, each group's value drivers and KPIs tie back
to those at the level above them, and so on, up to the level
of the CXOs. In other words, all KPIs are based on and tied
to the overarching corporate strategy and value drivers. In
this way, top-level KPIs cascade throughout an organization,
and the data captured by lower-level KPIs roll up to corporatewide
KPIs. This linkage among all KPIs, which can be modeled using
strategy mapping software, supports flexible analysis and
reporting at any level of granularity at any level of the
organization.
#4.
KPIs are Based on Corporate Standards
The
only way cascading KPIs work is if an organization has established
standard measurements. This is deceptively hard. It can take
organizations months if not years to hash out the meaning
of key measures or entities, such as "net profit" or "customer."
Functional representatives at a major U.S. airline spent months
trying to agree on the meaning of "flight" and "segment" and
their entire analytical infrastructure was put on hold until
they achieved consensus. In some cases, organizations can
only agree to disagree and use meta data to highlight the
differences in reports. Only with enough top executive support
(i.e. CEO) can organizations overcome the political obstacles
associated with standardizing definitions for commonly used
KPIs.
#5.
KPIs are Based on Valid Data
When
pressed, most executives find it easy to create KPIs for key
value drivers. In fact, most industries already have a common
set of metrics for measuring future success. Unfortunately,
knowing what to measure and actually measuring it are two
different things. Before executives finalize a KPI, they need
to ask a technical analyst if the data exists to calculate
the metric and whether it's accurate enough to deliver valid
results. Often, the answer is no! In that case, executives
either need to allocate funds to capture new data or cleaning
existing dirty data. Or they need to revise the KPI. Providing
cost estimates for each approach will help executives decide
the best course of action.
#6.
KPIs Must Be Easy to Comprehend
One
problem with most KPIs is that there are too many of them.
As a result, they lose their power to grab the attention of
employees and modify behavior. According to TDWI research,
the median number of KPIs that organizations deploy per user
is seven. More KPIs than this makes it difficult for employees
to peruse them all and take requisite action.
In
addition, KPIs must be understandable. Employees must know
what's being measured, how it's being calculated, and, more
importantly, what they should do (and shouldn't do) to positively
effect the KPI. This means that it is not enough to simply
publish a scorecard; you must train individuals whose performance
is being tracked and follow up with regular reviews to ensure
they understand and are acting accordingly. As one IT manager
said, "Measurements without meetings is useless."
#7
KPIs Are Always Relevant
To
ensure that KPIs continually boost performance, you need to
periodically audit the KPIs to determine usage and relevance.
If a KPI isn't being looked at, it should probably be discarded
or rewritten. In most cases, KPIs have a natural lifecycle.
When first introduced, the KPI energizes the workforce and
performance improves. Over time, the KPIs lose their impact
and should probably be revised. Most organizations review
and revise KPIs quarterly.
#8.
KPIs Provide Context
Metrics
always show a number that reflects performance. But a KPI
puts that performance in context. It evaluates the performance
according to expectations. The context is provided using 1)
thresholds (i.e. upper and lower ranges of acceptable performance),
or 2) targets (i.e. predefined gains, such as 10% new customers
per quarter), or 3) benchmarks, which can be based on industrywide
measures or various methodologies, such as Six Sigma. In addition,
most KPIs indicate the direction of the performance, either
"up" "down" or "static".
#9.
KPIs Empower Users
It's
commonly stated that you can't manage what you don't measure.
But a corollary is that you can't manage what you don't reward.
To be effective, KPIs must have incentives attached them.
Almost 40 percent of organizations surveyed by TDWI say that
they restructured incentives systems when implementing KPIs.
However, it's important not to link incentives to KPIs until
the KPIs have been fully vetted. Often, KPIs must be tweaked
or modified before they have the desired effect.
It's
also critical to revamp business processes when implementing
KPIs. The business process needs to empower users to take
the appropriate action in response to KPIs. The last thing
you want is informed, but powerless users. That's a recipe
for disillusionment and poor morale. Forty percent of organizations
said they modified business processes when implementing KPIs,
according to TDWI research.
#10.
KPIs Lead to Positive Action
Finally,
KPIs should generate the intended action - improved performance.
Unfortunately, many organizations allow groups to create KPIs
in isolation. This leads to KPIs that undermine each other.
For example, a KPI for a retail store might track stock outs
(where it doesn't have enough merchandise on hand to meet
demand) but the regional warehouse is incented to carry minimal
inventory. If the regional warehouse does too good a job,
it may not have enough inventory to keep the retail shelves
stocked when there is a surge in demand for certain merchandise.
Another
problem is human nature. People will always try to circumvent
KPIs and find loopholes to minimize their effort and maximize
their performance and rewards. Good KPIs are vetted before
deployed and closely monitored to ensure they engender the
intended consequences.
Conclusion
If
you have read this far, I hope you are convinced that KPIs
are a breed apart from your run-of-the-mill metric. While
an organization may have hundreds, if not thousands of metrics,
it should only have a few dozen KPIs that focus employees
on the key activities that deliver the most value to the organization.
In
essence, KPIs are communications vehicles. They enable top
executives to communicate the mission and focus of the organization
and grab the attention of employees. When KPIs cascade throughout
an organization, they ensure everyone at every level is marching
together in the right direction to deliver the most value
to the organization as a whole.
Wayne
Eckerson is director of research at The Data Warehousing Institute.
He recently wrote a report titled Best Practices in Business
Performance Management: Business and Technical Strategies
. The report is available free of charge at www.dw-institute.com/research
