This article is the starting point or module 1 of our KPI Master Class. We will be publishing additional KPI articles to explain the additional modules of creating best practice for the KPI Reporting Process.
Some say that “what gets measured, gets managed, gets done”. But what if you are not giving the appropriate priority to measuring the things that your business, your profit and your cash flow is most sensitive to? What if, therefore, you are measuring the wrong things? Then, inevitably, you will be managing the wrong things and doing the wrong things. And failing to achieve goals and hit targets – again.
Why, you may ask do people measure the wrong things?
Because they don’t know where their true sensitivities lie. Why not? Because they haven’t measured them.
So, we need to measure our measures to make sure that our measures measure up!
We should all measure our businesses using Key Performance Indicators (KPIs). But we contend that most businesses are using the wrong KPIs or perhaps the right ones used wrongly. In this article, we aim to explore what KPIs should be and why they are critical to business growth and performance. It is an extensive article with valuable content all the way through, finishing with a simple solution to a complex issue. So stay with us to the end.
Key Performance Indicator Definition
These are defined in UK Companies Legislation and by many others. However, we don’t like any of them as they are not clear and they do not focus on the right things. Here’s our definition. Key Performance Indicators are:
Specific empirical results of performance against target measured from the sensitive areas of the business and used by management to determine probable future performance based on current fact.
They must only measure elements of the business that can be controlled and changed. This means structured processes and people’s behaviour.
Definition of other terms
Let’s define some of the terms that will pop up in our various discussions on KPIs. We have used the English Oxford Dictionary’s definition of most of these terms:
- noun – a standard unit to express the size, amount, or degree of something
- verb – asses the importance, effect, or value of something
- noun – a system or standard of measurement
- noun – a thing that provides a means of achieving or understanding something
- noun – a task or operation seen in terms of how successfully it is performed (carried out)
- noun – a gauge or meter of a specified kind
- noun – a thing that indicates the state or level of something
- verb – suggest as a desirable course of action, point out, show
- Based on, concerned with, or verifiable by observation or experience rather than theory or assumed logic.
- A part of the business (or structured process) where a small change in performance leads to a large change in the outcome you are looking for. (UB definition)
- A clearly defined, step by step process, which something or someone must accomplish, in order of priority, to achieve a specific goal. (UB definition)
Examining our KPI definition
Bearing the above in mind, we’ll look at those three words again and what we think they should mean.
Remember we call them key performance indicators, not just all performance indicators or any performance indicators or just plain old performance indicators! They are key performance indicators. “Key” means that your chosen measures must only encompass the few things that are of crucial importance to the operations you are managing – the sensitive areas which as defined above are the areas where a small change in performance leads to a large change in your desired outcome – for instance a small change in sales conversion ratio could generate a larger percentage of change in profit.
Does this accord at all with the Oxford Dictionary definition of key? Let’s check. Well, it does provide a means of achieving or understanding something and it is crucial so, yes.
“Performance” means that your KPIs need to measure progress towards success or failure in the operation it is tied to. So, the KPI must measure only elements which drive the outcomes required to achieve a business’s mission or strategy. This also agrees with our dictionary definition.
Now here’s the kicker. They are supposed in indicate something. To be fair, the definition is fulfilled just by them showing the level of something or by being a gauge or meter. But the definition of the verb “to indicate” would mean that they are supposed to point something out, or suggest a desirable course of action – something we must DO. What do we mean by that? Well, these are not rear-view mirrors, these are windscreens! They are not intended to show you where you have been but to be applied to show where you are likely to end up. They are there to indicate progress and to help you predict what is going to happen next, and then let you adjust behaviour (yours or someone else’s) accordingly.
They do say that “hindsight is a wonderful thing” but we would say that foresight is even better.
So what are KPIs for?
We evangelise the power of measured data translated into useful KPIs aligned with the correct business strategy including realistic desired outcomes and specific, measurable action plans (structured processes). In fact, this is a large part of what we do. However, we feel that these definitions and many others like them are missing some key points.
There is a lot of literature around on KPIs and much of it talks about lag measures and lead measures. A lag measure is concerned with measuring the overall goal you are trying to accomplish (for instance, profit or cash) and it is always looking to the past. It may still be a very important measure, but once you have it there is very little you can do about it. On the other hand, a lead measure is predictive, meaning that they lead to the lag measures, and also you can do something about them (Source: Brian Critchfield 2013). Lag measures will not help you change course, only lead measures will.
So, our question is – are we trying to create something that helps us understand our position looking backwards or are we trying to find assistance in looking forwards and choosing what to do next?
And in answer we have realised that there are really two camps of KPI, both of which can fit the Oxford Dictionary definitions but one of which is more valuable to a management team that is engaged in changing performance for the better. The two camps are divided by the reporting frequency as well as the reporting audience and, crucially, whether they are lead or lag measures.
The first camp is made up of less frequently produced measures provided for an external audience who are likely to focus on achieved financial results, and are all lag measures. For that external audience, these measures or more accurately the trends of these measures do provide an indication of external performance and they are all that is available so for that audience they are KPIs.
But we contend that for the second camp, the internal audience, these same lag measures are just results. Why? Because they do not in themselves highlight areas where changes can and should be made to maintain or enhance the performance. They are not measuring what people are doing. The internal audience has the luxury of choosing any measures as their KPIs and so they should focus on measures of things that are happening in the business that can be quickly affected by their decisions. They must be lead measures that help you look into the future.
We need an example, so let’s think about a structured sales process. We should not be using this period’s sales achieved as a KPI. It is a metric, or measure, but it only tells us what has happened and is not an indicator of what might be going to happen. The indicators are those measures of for instance, calls made, or appointments made, or deals closed, or value of deals closed, or overall conversion ratio, or profit per unit achieved. These are the activities that lead to the sales and profit achieved number and it is changes in these activities that need to be monitored and then the people doing the activities managed accordingly – let’s say for example, re-trained in a specific area of their sales process.
Let’s remember what a business is and what financial results or even KPI data represent. At its most basic level, a business is really a group of people doing things and interacting with other people who are also doing things. Of course, it may use computers and machinery and maybe even robots and they are doing things too, but there’s always people deciding what the machines do. So, if we take our financial results, they are only a big sum of the monetary effects of all the things that people did in each period. Given that, how do we change business performance? We change what the people in it do and what they achieve (how you change what they do is an entirely separate discussion). After all, Einstein did define insanity as repeating the same action and expecting a different result.
And that’s not all. We must keep in sight the real point of KPIs. It is not only to have a few key measures to indicate the direction of performance or even the direction of performance change. The real purpose is to increase the efficiency with which this vital information can be imparted to and assimilated by decision makers so they spend much less time looking at the information and much more time acting on what they have learned. They are there to reduce information overload and prevent “analysis paralysis”. What gets measured, gets managed, gets done – but not if we spend our whole time wading through piles of reports!
- Further advantages of a robust KPI reporting process include:
- Making budgeting and forecasting an easier and more accurate process.
- Providing a valuable tool to re-engineer pay plans which can in turn reduce staff turnover
- Imparting a very positive message to banks, shareholders and investors
- Powerfully motivating the people in the business
So what KPIs should I choose?
The right KPIs will vary from business to business and must be derived for each business through careful consideration to identify what truly drives that business.
If you find that you have a long list of what you are calling KPIs, then these are just measures because they are cannot possibly all be key. A measure tells you where you have been. Some of these measures record critical outcomes and are Key Performance Measures (KPMs). Some of these Key Performance Measures also indicate where you are going and these are KPIs. In fact, the key to understanding KPIs is to differentiate between KPIs and KPMs.
However, whatever the business, a good KPI is tightly linked to a good strategy. Consequently, it is not possible to come up with a good KPI in the absence of a good strategy. A good strategy requires analysis of the problem, setting realistic outcomes, and specific, measurable actions (structured processes) that can be taken to reach the desired outcome. Sometimes people are measuring the wrong things because they haven’t clearly sorted out what their strategy is, what their goals are and what the definition of success is.
How do I work out what they should be?
It is important to be careful and considered. Just as much as a good KPI will drive desirable behaviour, a bad one will drive undesirable and dysfunctional behaviour just as effectively.
We heard an example recently where a council, much praised for its recycling levels, was discovered to be putting most of the recycling into land fill along with ordinary rubbish. Why? The KPI applied was the amount by weight of recycling collected but with no measure of what actually happened to it.
And we’ve all seen measures of headcount or employee costs that have driven departments to take on third party suppliers to achieve their workload and yet stay within the “KPI”, managing to increase costs in the process!
As we stated at the very start of this article, many businesses end up measuring the wrong things because they do not know where their true sensitivities lie. It is vital that you identify where these are.
Our process involves creating a simulation of the business. To do this we build a comprehensive model of how the business works and then use special software to run this model thousands of times using automatic small changes to all the variables. This enables us to see where the model is most sensitive and then test those indicated areas back to the business. Once confirmed, we check that this sensitivity is something that is within the company’s power to control. If so, then measures around the people and processes that affect that sensitivity become KPIs.
We then work with and around the reporting systems that are already used in the business to extract, summarise and present your data as easily produced, attractive and accessible reports which properly present the metrics we have now agreed the business must monitor. We take advantage of recent advances in software that enables businesses to prepare their own “business intelligence” based on their current systems and without having to make large investments.
It is worth highlighting again that in our view it is possible to have a sensitive area that you cannot control. This may well be a Key Performance Measure as in it will influence your performance and you will want to know what that effect has been. But it is not a KPI because you can’t use the information to change anything. An example here might be a business that is exposed to exchange rate movements or fuel prices. These may have a significant impact on the business’s profits and cash flow but there is nothing that the business can do to change or control these exchange rate movements or fuel prices. Of course, if you can’t control it and you are sensitive to it, then if it is possible you may choose to hedge it. And if you do hedge it, then you have effectively fixed the rate, it will no longer affect performance and so it’s still not a KPI!
What reasons do others give for not implementing KPI reporting?
Some reasons we have come across have included the following:
- It will take too long
Not with properly designed reporting processes
- We can’t automate all the data collection
Just because you think you can’t doesn’t mean you can’t! However, you can also implement well designed manual control forms
- I don’t trust my people to collect the right information
This sounds like you need help with some management challenges or recruitment and training difficulties
- My people will never do this daily, let alone weekly
As for the point above
- I only need a monthly report
Please explain how and why you would not want to “tune” your business processes as the month progresses…
We are sure that it has quickly become evident that not one of these resistances makes a case against the value of the KPIs themselves but they do indicate management issues that the business may be facing. Which is of course the exact point of KPIs in the first place!
In fact, the kind of resistance shown above indicates a loss of situational awareness in the businesses concerned.
What do you mean by situational awareness?
Situational awareness is being aware of what is happening around you and applying that knowledge to understand how information, events and one’s own actions will impact goals and objectives both immediately and in the near future. (UB definition)
Situational awareness has been formally defined (Endsley 1995(b)) as consisting of a person’s state of knowledge about a dynamic environment which incorporates the perception of relevant elements, comprehension of the meaning of these elements in combination with and in relation to operator goals, and a projection of future states of the environment based on this understanding. Endsley goes on to state that by using this knowledge, individuals with good situational awareness will have a greater likelihood of making appropriate decisions and performing well in dynamic systems.
It is especially important in work domains where the information flow can be high and poor decisions may lead to serious consequences and it has been recognised as a critical yet often elusive foundation for successful decision making across a broad range of complex and dynamic systems and processes. (Wikipedia)
Situational awareness requires an advanced level of situational understanding (which in turn can be enhanced by good measurement) and a projection of future system states in light of the operator’s pertinent goals.
The operators of large, complex systems (like a business for instance) must also rely on up-to-date knowledge of situation parameters to manage effectively. In their tasks, operators must observe the state of numerous system parameters and any patterns among them that might reveal clues as to the functioning of the system and future process state changes (Wirstad, 1988). Without this understanding and prediction, human control cannot be effective.
Acquiring and maintaining situational awareness becomes increasingly difficult, however, as the complexity and dynamics of the environment increase. In dynamic environments, many decisions are required across a fairly narrow space of time, and tasks are dependent on an ongoing, up-to-date analysis of the environment. Because the state of the environment is constantly changing, often in complex ways, a major portion of the operator’s job becomes that of obtaining and maintaining good situational awareness. This task ranges from trivial to one of the major factors determining operator performance.
Situational awareness is based on far more than simply perceiving information about the environment. It includes comprehending the meaning of that information in an integrated form, comparing it with operator goals, and providing projected future states of the environment that are valuable for decision making.
The relationship between situational awareness and performance, though not always direct, can also be predicted. In general, it is expected that poor performance will occur when situational awareness is incomplete or inaccurate, and therefore good situational awareness can be viewed as a factor that will increase the probability of good performance.
Dangers of losing situational awareness within a business include:
- Not maximising profit
- Poor sales performance
- High marketing costs per sale
- Lack of manufacturing efficiency
- Low self-esteem of employees
- High levels of staff churn
- Inability to secure funding for expansion
- High costs for goods or services
- Loss of competitive advantage
- Ultimate business failure
The first step in achieving situational awareness is to perceive the status, attributes, and dynamics of relevant elements in the environment and yet not all system designs are equal in their ability to convey needed information or in the degree to which they are compatible with basic human information-processing abilities. For example, think about the difference between reports made of reams of pages numbers printed in a small font – and a page of relevant and intelligent graphics displaying the same information. Which will you find easier to process?
In a study of pilot situational awareness, Fracker (1989) showed that a limited supply of attention was allocated to environmental elements based on their ability to contribute to task success. Because the supply of attention is limited, more attention to some elements, resulting in improved situational awareness on these elements may, however, mean a loss of situational awareness on other elements once the limit is reached, which can occur rather quickly in complex environments. In an investigation of factors leading to fighter aircraft accidents involving controlled descent into the terrain, Kuipers et al. (1989) cited lack of attention to primary flight instruments (56%) and too much attention to target planes during combat (28%) as major causes. Focusing on only certain elements led to a lack of situational awareness and fatal consequences.
The way in which information is presented via the operator interface will largely influence situational awareness by determining how much information can be acquired, how accurately it can be acquired, and to what degree it is compatible with the operator’s situational awareness needs. As a result, one seeks designs that will transmit needed information to the operator without undue cognitive effort.
And in our view this transmission of relevant and required information without undue cognitive effort is achieved by the use of well-designed and appropriate KPIs.
A business can avoid losing situational awareness by:
- Developing a clear strategy
- Identifying realistic Strengths, Weaknesses, Opportunities and Threats
- Engineering effective, company wide structured processes and adhering to them
- Implementing company wide KPI reporting procedures
- Implementing efficient and effective weekly management KPI meetings for every department
- Re-engineering recruitment processes to find and keep good people
- Delivering structured training programs relative to the job descriptions of every employee
How do I get the most out of my KPIs?
As we have stated before, the real purpose of measuring performance is to drive future improvements in performance. So, we must use our KPIs in the light of that intention and take the following steps.
- Define your strategy. If you have already done this – revisit it. A good KPI is tightly linked to a good strategy. Consequently, it is impossible to come up with a good KPI in the absence of a good strategy. A good strategy requires analysis of the sensitive areas of the business, setting realistic outcomes, and specific, measurable actions (structured processes) that can be taken to reach those desired outcomes. The strategy must be measured against realistic targets.
- Determine your appropriate KPIs and implement the reporting structures to deliver them – without undue cognitive effort.
- Schedule and hold regular reviews. KPI reporting will be a complete waste of resource unless the business leaders hold a weekly management KPI meeting, where each department head delivers their KPI report in ten minutes or less. This places a demand for department managers to be inspired to achieve their monthly targets, motivated to rectify under performance, excited about developing strategies to expand and improve performance, empowered to make improvements within documented authority limits and have a profound understanding of the importance of KPI reporting. KPI Training is crucial.
- Reverse engineer your KPI reporting so that the reports themselves can tell you the performance levels required to get a section of a structured process back on track. Ask yourself this: how many times this year did you fail to hit your sales unit and profit targets? Our philosophy of reverse engineering KPI reporting will mitigate this risk.
- Use your KPIs to spot potential problems or opportunities. Remember, your KPIs indicate trends in your business performance, they are windscreens not rear-view mirrors. If the trends are moving in the wrong direction, you know you have problems to solve. Alternatively, if the trends move consistently in your favour, you may have greater scope for business growth than you had previously forecast. An example might be to recruit more staff, because if your staffing is out, how will you hit increased targets?
We hope that we have changed your perception of the relevance and importance of KPI reporting.
If as we suspect you are now thinking about them in a different way, and wondering what to do next…
- Interrogate your current KPI reporting processes to ensure that what you are calling KPIs are really KPIs and not just Key Performance Measures.
- Interrogate your strategy.
- Interrogate the level of structured process you have implemented across the entire business.
- Review the effectiveness of your review procedures – remember no manager should take more than 10 minutes to present their KPIs.
- No time? Not sure how to define the sensitive areas? Unsure of how to implement the changes so they become permanent? We’re here to help.
Module 1 is the first in a series of articles relating to Key Performance Indicator reporting.
Module 2 will advise on how to structure a Process to achieve best possible conversion ratios, and how to measure the effectiveness. If the process is wrong, the KPIs will be wrong.
Module 3 will discuss the importance of using Psychometric Profiling when changing for the better people’s behaviour who work within a Structured Process.
Module 4 explains how Microsoft Excel 2016 which include the Power BI add ins can make KPI reporting simple an easy to use. Not forgetting that if it looks good, it usually is good. This will all have a positive, subliminal effect of those who use professionally engineered KPI reporting tools.
Module 5 will explain the importance of developing the skills of managers to not only understand the importance of KPI reporting in areas such as rectifying a down turn in performance, looking to the future to improve performance and how to deliver meaningful, weekly Management KPI reports to decision makers in under 10 minutes. What gets measured, gets managed, gets done, without meaningful weekly management KPI meetings, KPI reporting is a complete waste of time.
If you want more information contact Harry Le-Moine
- Wikipedia: Situational Awareness: https://en.wikipedia.org/wiki/Situation_awareness
- Endsley, M.R.1995(b): Toward a Theory of Situation Awareness in Dynamic Systems. Human Factors Journal 37(1), 32-64. Our particular thanks to this reference. Most of the section on situational awareness is derived directly from this work with some additions of our own. The complete work can be found here
- Wirstad, J. (1988). On knowledge structures for process operators. In L. P. Goodstein, H. B. Anderson, and S. E. Olsen (Eds.), Tasks, errors, and mental models (pp. 50-69). London: Taylor & Francis (reference form Endsley).
- Fracker, M. L. (1989). Attention gradients in situation awareness. In Situational awareness in aerospace operations (AGARD-CP-478; pp. 6/1-6/10). Neuilly-Sur-Seine, France: NATO-Advisory Group for Aerospace Research and Development (reference form Endsley).
- Kuipers, A., Kappers, A., van Holten, C. R., van Bergen,J. H. W., and Oosterveld, W. J. (1989). Spatial disorientation incidents in the R.N.L.A.F. F16 and F5 aircraft and suggestions for prevention. In Situational Awareness in Aerospace Operations (AGARD-CP-478, pp. OV-E-l-OV-E- 16). Copenhagen, Denmark: NATO-Advisory Group for Aerospace Research and Development (reference form Endsley).
- Critchfield B 2013; Lead Measures vs. Lag Measures https://navelmarketing.com/2013/04/16/lead-measures-vs-lag-measures/