Key Performance Indicators (KPIs) are a way to measure the success of a business, team, or employee in meeting the key objectives for performance. KPIs are useful for businesses of all sizes and can be used at every level of your organisation as a tool to focus on achieving your goals.
Businesses are more likely to be successful if they have a plan. Measuring the success of that plan in a way that encourages the right behaviours requires on-going effort. Plans evolve, and therefore so do our KPIs. Given the challenges that small businesses are facing in 2020 we thought that a reflection on effective KPIs would be useful.
What makes a good KPI
A good KPI will be SMART, balanced, and transparent.
Set SMART goals that you can evaluate performance against by using SMART KPIs.
Your performance measurement system strongly affects the behaviour of your team. Therefore, it is important to take the time to ensure that everyone is on the same page with regard to your overall goals and the objectives in place to achieve them.
The SMART framework is well known and very good tool to ensure alignment to your objectives and goals. The framework has a few variations
so we have set it out below:
Specific – Clearly defined and easily understood. Not only that, everyone needs to understand why the KPI is important.
Measurable – You should be able to measure the KPI in a timely manner. This is so you know when you have achieved your goal. Remember, what you measure is often what you get.
Actionable – Having an action oriented KPI means that something can be done to improve the outcome. The team should be inspired towards taking the steps that move you towards your overall goals.
Realistic – The KPI needs to be possible and relevant. It helps if the indicator is within your control.
Time-bound – Have a defined time period that makes sense in terms of your reporting cadence and the ability to collect enough meaningful data.
One of the most common mistakes that we encounter is KPIs that are too focussed on one part of the business, most often financial. Financial indicators are useful because they tell us how effective our past actions have been. They become even more useful if we also consider operational measures and the more forward looking non-financial information. A good set of KPIs will have the following elements:
Financial & Non-Financial Indicators
Financial indicators measure the dollars and are typically found in your profit & loss or balance sheet. For example, they will derive from revenue, profit margins, cash, your assets, liabilities and equity.
Non-Financial indicators measure regularly occurring activities within your business. These indicators provide an
alternative perspective and can provide invaluable insight into your operations. The non-financial information is often also a lead
indicator or hint at future financial performance.
Lag & Lead indicators (History and Future)
It is motivating to reward achievements as well as contributions toward the future.
Lag indicators provide an analysis of what happened in the past.
Lead indicators provide an indication of future performance. We need to consider both so that we learn from the
past but have a clear view on what we will do next.
Operational & Strategic
The success of your business depends on having processes and systems in place that support the achievement of the business strategy and business plan. Therefore, it is wise to include indicators for both in a set of KPIs.
Operational Indicators are those that measure whether the business is operating effectively and efficiently in the day-to-day – our processes that are in place drive the business and improve its outcomes.
Strategic Indicators are those that measure whether the business is achieving the high-level goals set by owners.
Short & Long Term
If you’d like to build a resilient business that stands the test of time, then it’ll be a good idea to develop a strategy and implement delivery of that strategy over both the short and long term. Clearly, you’ll also want your KPIs to focus on both.
Too much focus on the short term can jeopardise long term performance but nevertheless are still critical to include. Your long term indicators are more likely qualitative, or non-financial.
Consider the different perspectives that drive success
The trick here is to think broadly about your business as well as all of the stakeholders and align to your strategy, vision, values and goals. A great tool to use it the Balanced Scorecard (Robert Kaplan & David Norton), which will split your KPIs into four perspectives (or five if you include sustainability in your strategy) :
Financial perspective. The financial perspective gives us a view on whether or not we are achieving success for our shareholders or owners and whether we are achieving the financial outcomes necessary to achieve our goals. The indicators likely focus is on increasing revenue, decreasing costs, measures of resilience, cash cycles, improved utilisation of assets and return on investment.
A few examples : Monthly Recurring Revenue (MRR), Revenue per Employee, Current or Quick Ratio, Return on Investment annually, Gross Profit, Net Profit, Cash Conversion Cycle, Debt to Equity Ratio.
Customer perspective. How do we identify whether we are adding value for our customer, or that our customers are happy? The indicators will focus on customer satisfaction, retention, acquisition, profitability or fit, and market share. These are outcomes that show us that our strategy is being delivered.
A few examples : Referrals from existing customers, Net Promotor Score (NPS), number of repeat customers per month. Dollar value of re-work, number of avoidable complaints, lead times.
Innovation & learning perspective. How do we innovate, improve and create value? These indicators take into account the motivation, learning, and growth of our team and also consider the use of technology in our business. We need to ensure that our team is aligned with our strategy, and that they are building the skills and capability to deliver on our goals.
A few examples: Employee turnover per year, training hours per month, new ideas implemented annually, eminence or recognition as an expert or progressive voice.
Internal Process Perspective. What are the processes we need to nail in order to succeed? These indicators will reflect the effectiveness and efficiency of our processes and track improvement.
A few examples : Number of projects completed under budget, number of injuries, utilisation rates, hours saved via process improvements.
Sustainability Perspective. How can your interaction with the environment and society create positive outcomes for both your business and the World it operates in? Sustainability is not part of the traditional balanced scorecard but we think it is worthwhile including, especially if sustainability is built into your strategy.
A few examples: Carbon footprint, energy consumption, water use, pro-bono hours, waste reduction, waste diverted from landfill.
Communication and Transparency
Developing good KPIs is only part of the story. To ensure they are effective you need to make sure that everyone in your organisation understands why they are important, knows how they can contribute and what they are responsible for. Involving your team in the development of the KPIs is a good way to encourage buy in and also to benefit from the ideas and knowledge of those at the coal face.
Finally, transparency and good communication is critical. Don’t let all that good work go to waste by not communicating the progress! Reporting regularly, using the KPIs in your meetings or one-to-one’s can be really useful. Creating a dashboard or using cloud technology is a great way to achieve this and also adds an element of interaction and depth to your planning meetings.
Common snags & our tips to avoid them
Too many KPIs
Too much information can lead to a lack of focus and disengagement. People are less clear on what is important. Keep it simple and you’ll benefit from the clarity, focus and engagement that this encourages.
Early in my career, I created a management report and balanced scorecard for a large financial services firm. I followed the advice of the incumbent CFO and spent 3 months crafting a 45 page masterpiece. That CFO left the business shortly afterwards and the replacement stormed into my office, slammed the report on my desk and told me it was one of the most turgid and ineffective documents she had ever seen. Asleep at page 5 apparently! I was told to do it again, make it no longer than four pages, be more forward looking and restrict the amount of colours to less than five. This sounds extreme and user dependent but it is good advice. The art of keeping something simple requires plenty of thought about what is important and why.
Narrow KPIs that focus only on financials or internal outcomes
As described above, it is important you try to take a balanced approach so that you gather the full picture and are more likely to execute on your plans into the future. To help with this, dust off the business plan and reflect on it. What are the goals? What are the critical success factors or key objectives that ensure success? Make sure you engage with your team, take a look at job descriptions, map out your value chain, and think through all of the stakeholders involved in your business.
Ineffective financial KPIs
Be careful of using percentages on their own (e.g. a gross profit % as a KPI). Often it is better to go with a defined dollar amount, or combine that percentage with a defined dollar outcome. For example, if your revenue is 50% below target but you achieved your gross profit margin, is that a good outcome?
We recently saw a marketing agency that had set a gross profit margin of 40% as a KPI. If the KPI was achieved, a bonus was paid. If the KPI was missed, no bonus. The business exceeded its revenue targets by a healthy amount but returned a gross profit margin of 35%. In dollar terms, gross profit was ahead of target and so was net profit. Yet the KPI indicated a fail. The owners argued that the business would have done much better if the team had maintained margins at 40%. The employees argued that they worked hard and that in dollar terms exceeded expectations. The consequence was that skilled people left the business and those that remained reduced their productivity when it became apparent that they would miss the KPI.
A better approach may have been to set a dollar target rather than a percentage for gross profit, or alternatively a dollar target for
revenue along with a percentage for gross profit. The financial ratio on its own is a classic example of a KPI causing unintended havoc.
This example also illustrates an advantage that small businesses have – you can be agile, and change things quickly if they are not right.
Not considering the unintended consequences
Remember, what you measure is what you get. Taking a balanced approach helps with this. For example, if your KPI is to measure whether a job is completed within budget then your team may take short cuts and sacrifice quality in order to meet the target. If you have a more balanced approach which also measures customer satisfaction, then the unintended consequence is less likely. Good communication, and involving your team in the KPI development process can also help to ensure the right outcomes.
Setting KPIs that are outside of your (or your team’s) control
Ideally, you should set a KPI that is action oriented, which means that you can do something to improve the outcome.
Not aligning KPIs to strategy, or not updating KPIs after changes to the business plan
Like your business, your KPIs need to evolve. A classic example of this is a consulting firm that had a revenue dollars billed KPI for each consultant. Their 2020 strategy included emphasis on collaboration and teamwork, yet the KPIs did not change. The consultants were being told to work as a team but measured based on individual performance and for this reason the KPIs worked against the achievement of the strategy.
KPIs that are too complicated
If the KPI is difficult to calculate, or difficult to understand then it is less likely to be engaging, accurate, timely, or effective.
Remember – keep it simple, stick to the SMART theme, engage your team in the process, make sure you follow up and report accurately, and don’t forget to evolve.
There have been some big changes in the world this year and likely your business has had to change and adapt to ensure you remain competitive. If you would like a hand with your planning process, or assistance in revising your KPIs then make sure you get in touch – Now’s the time!