How to determine the right KPIs for your business

For many companies today, an important question is: Which subset of business data will give you the most strategic information to improve your business?

In Summary:

Measuring your organisation’s success depends on identifying and prioritizing the metrics that really matter. Using the wrong metrics can give you an incomplete or irrelevant snapshot of your business. Worse still, the wrong key performance indicators (KPIs) can create false confidence about your company’s direction.

Alan Walker, vice president of financial services at Hitachi Consulting’s London office and a performance management expert, tells of a bank in the United Kingdom that bungled its indicators. The bank sought to increase revenues with a new type of account. The bank’s top officers set goals for the number of new accounts each branch would be required to sell. The branch managers were told they would be evaluated on how well they met these sales targets.

“The managers went about signing up both old and new customers to these accounts with great gusto,” Walker says. “It all seemed very sensible.”

What was lost in the rush to sell these new accounts, however, was a key financial measure. The new accounts brought in less revenue to the bank than other established products. That important information was not communicated to the branch managers, who encouraged longtime customers to transfer from other (and, for the bank, more lucrative) accounts to the new, less profitable product.

For a while the sales numbers looked terrific. There was only one problem. The bank was losing money as a result of the shift from the older accounts to the newer ones.

“The performance of the business went radically downwards,” Walker says.

In this case, the bank’s top officers should have asked these fundamental questions: What is the goal for the current or new strategy? What would success look like? What measures should be used to gauge this success? And finally, could there be any unintended consequences by focusing on certain KPIs?

Instead of the measure “new accounts opened,” the bank should have focused on “new accounts opened for new customers,” Walker observes.

Discerning the difference between good and bad KPIs

Devote some thought to sorting out the good KPIs from the bad KPIs. Bad metrics tend to be vague and fuzzy. Good KPIs require a consideration of all the vagaries that can affect a number.

For example, simply defining a KPI as a measure of increased sales is not specific enough. Are you measuring sales by the monetary value (dollars, euros, yuan) or by units sold? How do you factor in returned goods? Then, incorporate goals into the KPI. Do you want to set a target increase in sales by dollar volume or percentage growth, and over what period of time?

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Strive for participation from all business departments when developing KPIs

Setting the right kind of goals and measures should be a group effort involving employees across your business. Gavin Boyd, the Johannesburg-based head of the Palladium Company’s Balanced Scorecard Collaborative African Unit, says that measuring business performance often means changing employee behavior, which is not always popular.

“People sometimes react less than positively when they realize that they are being measured,” says Boyd, whose organisation has helped some 2,500 companies implement business information systems.

Workshops that bring together board members and senior managers from different business units can help foster agreement on KPIs. The next step is to hold departmental workshops, where managers discuss with staffers the KPIs their department will be measured by, and why. Managers should consider linking employee rewards and sanctions to performance measured against KPIs. “This reinforces the importance of the KPIs,” Walker says.

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KPIs rely on integrated data from all departments

Once the KPIs are set, the next task is to measure them accurately across those same business units. Jim Brown, a vice president at Aberdeen Group, which specializes in industry benchmarks for product development, recommends creating a central data repository for all business groups. In measuring product development, for example, you might have to include data from sales and marketing, engineering, procurement, manufacturing, vendors, and even suppliers and customers (Microsoft SQL Server, for example, provides a data warehouse and analytical tools to help you manage business data).

For The Product Lifespan Management for Small to Medium-Size Manufacturers Benchmark Report, released in March 2006, Aberdeen surveyed scores of midsize manufacturing companies to see how they tracked their KPIs. The researchers found that 80 percent of organisations it listed as “best in class” had a key company officer who oversaw the data.

But the same survey also found that only 40 percent of the best in class collected and analyzed the data through various business intelligence (BI) solutions. None of the lowest-ranking companies have taken this step. Brown expects the number of companies using KPI systems to grow as more BI products come on line.

“It isn’t realistic to manage KPIs without the use of automation,” he says. “If you don’t have the information in a usable form, you can’t manage it.”

Fred Bayles is a Boston-based freelance writer. He is a former national correspondent for The Associated Press and USA TODAY.

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