In this blog I am looking into Key
Performance Indicators or KPIs. Often I see companies tracking and
reporting lots of KPIs only to find that they are only measuring
those things that are easy to measure and not measuring the things
that really matter. My advice is to reduce the number of KPIs that
you track, and only track those that will tell you how your business
is really performing, but accept that these will be harder to define
and measure.
It looks nice, but is it useful?
The importance of KPIs
In order to understand what's going on
in your business you need to define, measure and track Key
Performance Indicators (KPIs). A good set of KPIs will enable you to
understand if your business is meeting the targets that you have set
and all is well, or whether you are off track and need to take
corrective action.
It is easy to draw analogies. A captain
in charge of a ship needs to know his position and course as well as
the fuel and other supplies that he has on board in order to know that
he will reach his destination on time. At an annual check up your
doctor may measure your heart rate, height and weight to check that
you are healthy. He may also take a blood sample to measure useful
KPIs in your blood like cholesterol, glucose level and so on. Both
the ship's captain and the doctor are looking for irregularities in
the KPIs. If they are out of tolerance they will probably monitor
them more closely, investigate the root cause and take corrective
action to bring the KPIs back within tolerance.
How it should work
It's exactly the same for businesses,
and ideally you will have a hierarchy of KPIs that all link together
in a coherent pyramid. At the highest level you will be tracking
things like gross margin, Net Profit, Days Sales Outstanding,
Customer loyalty and so on. These should be aligned with the stated
goals of your business as agreed with shareholders. During the yearly
cycle these KPIs will show whether you are on target to meet your
objectives for the year or whether corrective action needs to be
taken.
At lower levels, though, your
organisation will be be divided into business units, functions, teams
and so on. Each of these groups will have objectives defined, which
if met should make the necessary contribution to the whole. They will
also be required to report the detailed figures that feed into higher
level KPIs.
In an ideal world, the pyramid of
objectives and measures is completely aligned. The highest level
objectives break down all the way to individual performance measures
for each employee and supplier and if everyone meets their targets,
the business as a whole meets it's target. If anything is going
wrong, then drilling down will enable you to quickly pinpoint where
exactly the problem is so that you can take corrective action.
How it usually works
In practice this seldom, if ever,
happens. Defining such a pyramid of objectives and measures is a huge
task and the world changes. On the one hand, it is human nature for us to isolate those
things that we can control, especially if we are being measured on
them. So a manager will want to define his KPIs based on his
department's performance isolated from the rest of the business. On
the other hand it can be complex and expensive to gather and process
all the necessary data. Objectives change from year to year, and there simply isn't enough time to build the perfect pyramid of KPIs for them to be useful in any meaningful sense. The pressure to find shortcuts is enormous,
and the question often asked is “what data do we already have that
will tell us more or less what we need to know?”
For an example, let's return to our
doctor and the annual check up. A widely used KPI is the Body Mass
Index or BMI. This is easy to define and measure. It is simply your
weight (in kg) divided by the square of your height (in m). In my
case I weigh 78kg and I'm 1.73m tall, so my BMI is 26.0 which makes
me overweight, so I should take corrective action. I should aim for
75kg or less . Although it is simple, the BMI has come in for some
well deserved criticism, because it doesn't always tell you what you
need to know to establish if someone is overweight, underweight or
just right. Since muscle is heavier than fat, athletes often have high BMIs. Methods for accurately measuring body fat
include calipers, electrical resistance or a full body X-ray scan.
BMI is an easy KPI to measure, but is not always useful
It's the same with the KPIs in your
business. Many of them have been defined not because they give you an
accurate measure of the health of your business, but because they are
easy to measure and are related to the things that you want to know.
A good example that many businesses measure is headcount. This is
easy to measure, and if combined with payroll data it's easy to turn
into money terms. So teams, departments and so on are set objectives
in terms of staff numbers or staff costs. It's easy to measure and
also relatively easy to control. As a result these objectives are met
in most companies. Next to this, a team or a department will often be
set a target in terms of output. By combining the two, you get an
idea of productivity in terms of output per unit cost. The chances
are though, that the output is defined based on what's easy to
measure and not what's important. Just because a team or department is meeting their targets, it doesn't necessarily mean that they are adding value to the business.
How poorly defined KPIs can encourage a
silo mentality
Consider the following scenario. A
retail insurance company consists of a sales and marketing
department, a claims department and a call centre that serves as the
first line for both.
The sales and marketing department has
a fixed budget for the year and a target for new contracts. For
simplicity all calls to the call centre that are logged as “new
contract” are counted towards this target. The claims department
has a fixed budget for the year and a target for processing claims
within a given timeframe.
The call centre also has a fixed budget and
a target of average handling time for inbound calls.
Based on experience, the sales and
marketing department have determined that the most cost efficient way
of generating leads is to launch a small number of high profile
campaigns, so plan 4 saturation campaigns spaced over the year. The
call centre manager meanwhile calculates that the most cost effective
way of staffing her call centre is to keep the headcount level and
avoid overtime as much as possible. She knows from experience that
she can manage the peaks by telling customers that they will be
called back later if the call centre is busy. This even helps boost
her average handling time KPI because both the initial call and the
callback are counted, so what could have been a single call is now
counted twice, and the average handling time is halved. What she
cannot afford to do is to authorise overtime or hire in temporary
staff to handle the peaks. That just increases her staff costs, and
leaves her overstaffed during the quiet periods (and when it's quiet
her agents spend longer with each customer, so the average handling
time goes up).
So, what happens when the sales and
marketing launch a saturation campaign? New customers suddenly start
ringing in asking to sign up or wanting more information. The call
centre can't cope and so does the bare minimum by logging the call
and promising to call back later. They keep their KPIs under control.
Critically each call is logged as a sales call, which feeds into the
sales and marketing KPI, so they also meet their targets. What
happens though when the customers are called back? Do they still want
the insurance policy now that they know that the call centre hasn't
got time for their call? Are they actually too busy right now doing
something else, after all they originally called at a time that
suited them? Have they checked out the competition and chosen their
product? Whatever happens, some of them who would have signed up for
the policy, now won't.
The point here is that each group is
hitting their targets, and can cite their KPIs to prove
it. It is clear though, that this company could perform better.
Objectives and KPIs could also be defined that are more relevant and
which encourage and reward better behaviour. For the sales and
marketing department, they should be aiming at total number of new
signed contracts. It's not the call that counts, but the signed
contract. The call centre shouldn't be measured on average handling
time, but on the notion of “first time resolution” i.e. did they
successfully respond to the customer's request in a single call.
When you start defining KPIs like this,
though, things start to become more complicated. Firstly the
definition becomes more complicated as does the means of measuring
it. Instead of just counting call logs you need to count new
contracts, and then distinguish between new contracts and extensions,
but what if a customer upgrades their contract, does that count as a
sale or not? Defining first time resolution is also not easy. How do
you distinguish between a customer who calls twice because the
initial enquiry was not adequately dealt with and a customer who
calls again for an unrelated matter?
Things also start to get more
complicated because managers are forced to recognise their
interdependencies. If the sales and marketing manager is now measured
on converted contracts, then he is dependent on the call centre
manager for ensuring that the calls generated by his TV advertising
campaign are converted into signed contracts by the call centre. The
call centre manager is also dependent on the sales and marketing
manager because her team will be swamped if there is a blanket
marketing campaign that generates large numbers of calls. A peak of
calls will result in a dip in first contact resolution or an increase
in headcount. This is a good complication, because it is clearly
true. These two managers and their respective teams are
interdependent, and if they are both to succeed, then they need to
talk to each other and work out a plan where they both win. Well defined KPIs should encourage these discussions.
How to define intelligent KPIs
First of all, start with the assumption
that the KPIs that you currently have are probably sub-optimal, that
they are based on what's easy to measure rather than what's important
to measure and that they are encouraging departments and teams to
work in silos rather than to cooperate. However, for now, they are
the best you have, so don't throw them away until you have something
better.
Before going any further take a good
look at your business and understand what really drives it. What
drives your revenues, what drives your costs and what are your most
important risks? What drives your competitive advantage and how
important are customer loyalty or fraud to you? What are the factors
that you can't control or which are the same for all competitors in
your market? (If it's the same for everyone, there's no need to worry
about it.)
Once you have an understanding of the
most important drivers, define a small number of KPIs that
meaningfully represent these. Recognise that they will not tell you
everything, but they will tell you the most important things. They
will probably not be easy to measure, and neither will they align
closely with your organisational boundaries. For both of these
reasons, the discussions that you need to have will be difficult, but
having those discussions is a valuable process in its own right –
those discussions help to break down the silos and expose the
inter-dependencies. Once you have defined these KPIs, then implement
them. The data may be hard to find, or the processing to turn raw
data into meaningful measures may be complex – that's one reason
why you should limit the number of KPIs. Once you start measuring
them, reporting on them and managing against them, you will discover
new complications. Be prepared for some degree of iteration before
the definitions and the targets stabilise.