Key Performance Indicators (KPIs)

What to Measure?

Selecting what to measure is one of the most important tasks for those who wish to focus on and control organisational performance. 
Until recently, there has been a widespread belief among business executives that they can control the firm’s performance with little more than the firm’s financial information.

Early Warning Signs

Most key performance indicators (KPIs) tell us how we have done in the past.

It is important to classify measures according to whether they tell us about the past or give an early indication of what is likely to happen in the future.

For example, we may get a report that shows a big increase in the number of units sold in the latest month. This is a “lag” indicator – it tells us about the past. By itself, it is not a good indication of what is likely to happen this month or in future months. In the same report, we may also have a rapidly falling forward order book for the next few months. A change in forward orders is a “lead” indicator of sales units. It tells us what is likely to happen in the short-term future.

In managing strategic objectives we need to look for lead measures that give us early warning of what is likely to happen well into the future. So, our lead measures need to be grouped according to how much warning they give us and how reliable they are.

What are the Drivers?

If action is to be taken, if decisions have to be made, we would like these to be based on the best information available. Effective decisions are based on good knowledge and understanding of what has led to the current position and how future results can be influenced or controlled.

Therefore we need measures that tell us why or how a key indicator level was reached. We need to have measures of the key drivers of each area of performance.

The drivers of short term results may well be different from the longer term drivers. For example, in the short term (month to month) sales of building products are affected by specific advertising, promotion and temporary pricing programmes. In the longer term (say 5 years or so), strategic initiatives such as distribution agreements, partnerships with builders, cross-selling of products, development of new products and new uses for old products are more powerful influences.

As a result, we may have different explanatory measures for short term tactical target achievement than for achievement of long term strategic objectives.

Whatever these are, they provide guidance to our decisions, and point to and encourage action. Using these measures, our executives and teams are likely to make more effective decisions and are less likely to make decisions that lead to poorer results than intended.

It is also important to recognise the nature of these measures. They do not always measure performance directly, they help to diagnose a performance gap or help us to make better-informed decisions.

Where to Stop?

Clearly, if we attempted to make a complete list all of the “causes” or drivers of performance for an organisation, the list would be very long. We could look to the drivers of the performance, the drivers of those drivers, and so on …

There has to be some point at which we say that “enough’s enough!”.

We have found that we do not need to create many levels of causality before we gain no added value by going any deeper. Obviously, this has to be examined on a case by case basis. Nevertheless, the general rule is that as long as you have reasonable information on which to base a confident decision, you have gone deep enough. We have seen few instances where the hierarchy of drivers is more than about two levels deep.

Simplicity is also an issue here. If we provide too much information, it will either not be used or people will become confused and make poor decisions.

Also, cost is very much a consideration. If the cost of creating and maintaining extra measures is greater than the value added by having the information, it would be silly to include them.