T he alignment of KPIs with organization vision/mission/ strategies/objectives is the key to realizing bottom-line impact. The challenge is to develop KPIs that provide a holistic and balanced view of the business. Faced with potentially hundreds (if not thousands) of candidate metrics, how does one select those that are most meaningful? One potential approach is to think of individual KPIs not just as a singular metric, but as a balanced metric that incorporates several alternative dimensions. These dimensions include business perspectives (customer, financial, process and development), measurement families (cost, productivity, quality) and measurement categories (direct, additive, composite). By overlaying these various dimensions, one can create a framework for building KPIs that succinctly captures the most critical business drivers.
The KPI Perspective Dimension
Since the early 1990s when Robert Kaplan and David Norton introduced the balanced scorecard methodology for performance management, the conceptual framework has been enthusiastically embraced by corporate America. As a performance management tool, the balanced scorecard is designed to assist management in aligning, communicating and tracking progress against ongoing business strategies, objectives and targets. The balanced scorecard is unique in that it combines traditional financial measures with non-financial measures to measure the health of the company from four equally important perspectives:
Financial: Measures the economic impact of actions on growth, profitability and risk from shareholder's perspective (net income, ROI, ROA, cash flow).
Customer: Measures the ability of an organization to provide quality goods and services that meet customer expectations (customer retention, profitability, satisfaction and loyalty).
Internal Business Processes: Measures the internal business processes that create customer and shareholder satisfaction (project management, total quality management, Six Sigma).
Learning and Growth: Measures the organizational environment that fosters change, innovation, information sharing and growth (staff morale, training, knowledge sharing).
Although the focus of each perspective is distinctly different, there is a common thread of causality that provides a universal linkage between the four perspectives. For example, if a company invests in learning and growth to improve employee skills and elevate morale, then those results will be translated into improved internal business processes by leveraging best practices and change management programs such as Six Sigma and TQM. These activities will then result in superior quality products and services for the customer, which in turn will drive increased sales and an improved financial bottom line.
The KPI Family Dimension
Another important consideration in the development of KPIs is the selection of the appropriate measurement family to capture operational performance over time and then relate these KPIs to internal business and external industry benchmarks. Although the following list reflects common measurement families, different industries will have their own specific business drivers and related measures.
Productivity: Measures employee output (units/ transactions/dollars), the uptime levels and how employees use their time (sales-to-assets ratio, dollar revenue from new customers, sales pipeline).
Quality: Measures the ability to meet and/or exceed the requirements and expectations of the customer (customer complaints, percent returns, DPMO -- defects per million opportunities).
Profitability: Measures the overall effectiveness of the management organization in generating profits (profit contribution by segment/customer, margin spreads).
Timeliness: Measures the point in time (day/week/ month) when management and employee tasks are completed (on-time delivery, percent of late orders).
Process Efficiency: Measures how effectively the management organization incorporates quality control, Six Sigma and best practices to streamline operational processes (yield percentage, process uptime, capacity utilization).
Cycle Time: Measures the duration of time (hours/days/months) required by employees to complete tasks (processing time, time to service customer).
Resource Utilization: Measures how effectively the management organization leverages existing business resources such as assets, bricks and mortar, investments (sales per total assets, sales per channel, win rate).
Cost Savings: Measures how successfully the management organization achieves economies of scale and scope of work with its people, staff and practices to control operational and overhead costs (cost per unit, inventory turns, cost of goods).
Growth: Measures the ability of the management organization to maintain competitive economic position in the growth of the economy and industry (market share, customer acquisition/retention, account penetration).
Innovation: Measures the capability of the organization to develop new products, processes and services to penetrate new markets and customer segments (new patents, new product rollouts, R&D spend).
Technology: Measures how effectively the IT organization develops, implements and maintains information management infrastructure and applications (IT capital spending, CRM technologies implemented, Web-enabled access).
The perspectives and measurement families can now be combined to develop a KPI profile matrix (see Figure 1), which provides a construct for balancing the number and types of KPIs that are developed. The profile matrix also ensures the proper mix of financial and non-financial measures - typically a shortfall of most performance management implementations.
Figure 1: KPI Dimension Schema
The KPI Category Dimension
Once you have identified the perspective and the family dimensions, the next task is to determine what form the measure should take -- the category. An effective KPI is generally never just a raw data point, but some massaged data derivative -- ratio, index or weighted average. The first step in creating a derived measure is to standardize the measures so that comparisons across different divisions/functions/departments are consistent and not just an exercise in comparing apples and oranges. Normalization, the most common technique, places all the measures on a similar footing by equalizing them across a common organizational base (e.g., per employee, per square foot, etc.). Critical to successful implementation of such measures is an enterprise-wide commitment to this standardization process. Siloed business and function-specific metrics need to be eliminated and replaced with new enterprise standards that ensure enterprise-wide optimization.
After normalization, development of the category dimension is the next critical step. The potential options include several variations such as direct, percentage, ratio, index, composite and statistical categories:
Direct: The actual raw data value as measured (e.g., sales levels).
Percent: The comparison of the changes in performance of one value relative to the same value at a different time, geography, etc. (e.g., percentage change in sales vs. last year).
Simple Ratio: The comparison of one value relative to another to provide a benchmark for comparison of performance (e.g., average sales per day).
Index: A combination of several separate measures added together that result in an overall indicator of performance (e.g., (company sales growth)/(industry sales growth) for a specific geography).
Composite Average: The addition of the weighted averages of several similar measures that result in an overall composite indicator of performance (e.g., customer satisfaction composite is mixture of results from surveys, focus groups and product returns).
Statistics: Multiple measures such as mean, variance, standard deviation and variance that capture the spread and distribution of the performance measures (e.g., sales distribution by demographics, geography, channel).
Keep in mind that the evolution of effective ratios, indexes and composites is as much art as science. In most situations, the direct data elements that need to be incorporated in a specific KPI are quite apparent up front. The real challenge is in translating the data elements into meaningful derived metrics that reflect true business drivers.
The KPI Focus Dimension
After incorporating the perspective, family and category dimensions into the development of KPIs, one needs to consider the final overlay - the focus. The focus dimension reflects an eclectic mixture of views that further balance the development and selection of KPIs: Time Horizon - short-term vs. long-term, Planning - strategic vs. tactical, Indicator - lead vs. lag, Type - qualitative vs. quantitative, View - internal vs. external, Level - process vs. outcome, Purpose - planning vs. control.
It is important to screen the final KPIs to ensure that they are not all skewed toward short-term, quantitative, tangible and lag indicators, which are easiest to develop. For example, tangible assets such as investments, real estate and inventories are a lot easier to "dollarize" than intangible assets such as employees' skill, talent, knowledge and teamwork. Values for the latter are much more difficult to capture, but they are typically a much better indicator of the company's future potential.
The bottom line is that the creation of effective KPIs requires an extensive commitment in time and resources. The effort can be streamlined by incorporating the dimensions explored here.
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