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Winning KPIs 

Winning KPIs 

By David Parmenter 
January 31 2012

Accurate and appropriate definition of KPIs is vital for the effective use of Balanced Scorecards, argues David Parmenter.


The Balanced Scorecard (BSC) was one of the major breakthroughs of the 1990s. The groundbreaking work of Robert S. Kaplan and David P. Norton brought to management’s attention the fact that strategy had to be balanced, and that performance should be measured using a more holistic approach.

Here are six ways to adapt and apply the BSC model to the contemporary business environment.

1. Define what KPIs are and what they are not

Many companies are working with the wrong measures, many of which are incorrectly termed key performance indicators (KPIs). Few organisations really monitor their true KPIs as they have not defined what a KPI actually is.
 

 An airline KPI

Lord King set about turning British Airways’ (BA) declining performance around in the 1980s by reputedly focusing on one KPI. He was notified, wherever he was in the world, if a BA flight was delayed for a certain length of time. BA managers knew that if a plane was delayed beyond a predetermined threshold, they would receive a personal call from King. It was not long before BA aircraft had a reputation for leaving on time.

This KPI totally changed my understanding of KPIs and led me to develop the seven characteristics of a winning KPI.

KPIs:

  • Are nonfinancial measures, therefore they can’t be expressed in dollars, yen, pounds or euros

  • Are, in many cases, frequently measured 24/7, daily, or weekly

  • Are acted on by the CEO and senior management team

  • Clearly indicate what action is required by staff, so that staff can understand the measures and know what to fix

  • Are measures that tie responsibility down to a team, allowing the CEO, for example, to call a team leader, who can take the necessary action

  • Have a significant impact on the organisation, affecting more than one BSC perspective

  • Encourage appropriate action, having been tested to ensure they have a positive impact on performance and that their downside is minimal

The first characteristic warrants an explanation. Financial measures are a quantification of the outcomes of an activity. We have placed a value on the activity. Consequently, behind every financial measure is an activity. Financial measures are result indicators; a summary measure. It is the activity that you will want more or less of. It is the activity that drives the dollar, pound and yen result. Therefore, financial measures cannot possibly be KPIs.
 

2. Source your KPIs from the critical success factors of your business

The traditional BSC approach uses performance measures to monitor the implementation of the strategic initiatives, and measures are typically cascaded down from a top-level organisational measure, such as return on capital employed. This cascading of measures from each other will often lead to chaos, with hundreds of measures being monitored by staff in some form of BSC reporting application.

Critical success factors (CSFs) should be the source of all performance measures that really matter, the KPIs. It is the CSFs, and the performance measures within them, that link daily activities to the organisation’s strategies. CSFs affect the business all the time. It is therefore important to measure how employees in the organisation are aligning their daily activities to these CSFs (see Exhibit 1 below).

Many strategic initiatives are monitored through normal project reporting methodologies, such as acquiring new operations. These new initiatives will become business as usual only when the new business or product is part of daily activities. The strategic initiatives that affect business as usual can be better managed through monitoring measures in the CSFs.

Exhibit 1: How strategy and the CSFs work together

Exhibit 1



3. Beware of the “dark side” of performance measures

All actions and measures have intended and unintended consequences. Hence, every measure can have a “dark side”, a negative unintended consequence. In order to minimise the dark side you need to discuss with staff what actions they are likely to take in response to certain measures. Pilot measures, observe behaviour and then tweak how the measure is used so that the behaviours it promotes are the intended ones.

Unintended consequences

A city train service had an on-time measure targeted at train drivers that included some draconian penalties. The drivers who were behind schedule learned simply to stop at the top end of each station, triggering the green light at the other end of the platform, and then to continue the journey without the delay of letting passengers on or off the train. After a few stations a driver was back on time, while the travellers, both on the train and on the platform, were not so happy.

 

4. Limit your measures

I recommend a 10/80/10 rule for the number of performance measures in an organisation. Exhibit 2 explains the four types of indicators and the suggested mix: about 10 key result indicators (KRIs), up to 80 result indicators (RIs and performance indicators (PIs) and 10 KPIs in an organisation. Very seldom are more measures needed, and in many cases fewer measures will suffice.

Exhibit 2: The four types of performance measures

Types of performance measures (PMs)

Number of PMs

 

Frequency of measurement

Key result indicators give an overview of the organisation’s past performance and are ideal for the board as they communicate how management has performed in a critical success factor or BSC perspective.

 Up to 10

 Monthly, quarterly

Result indicators give a summary on a specific area (for example, yesterday’s sales). Performance indicators are targeted measures that tell staff and management what to do (for example, number of sales visits organised with key customers next week).

80 or so (when the number rises more than 150, you begin to have serious problems)

24/7, daily, weekly, fortnightly, monthly, quarterly

Key performance indicators tell staff and management what to do to increase performance dramatically (e.g., which aircraft need to be brought back on time).

Up to 10 (you may have considerably less)

24/7, daily, weekly

For many organisations, 80 RIs and PIs will, at first, appear totally inadequate. Yet on investigation, you will find that separate teams are actually working with variations of the same indicator, so it is better to standardise them. For example, the “number of training days planned for next month” performance measure should be consistently applied across all teams.

Based on the seven characteristics of KPIs, you will find 10 KPIs will suffice unless your organisation is made up of many businesses from very different sectors; in that case, the 10/80/10 rule can apply to each diverse business, providing it is large enough to warrant its own KPI rollout.


5. Monitor 24/7, daily or weekly if you want to create change

Show me a monthly performance measure and I will show you a result indicator, a KRI or a PI. It will never be a KPI. How can it be key to your business when you are looking at the measure well after the horse has bolted?

If you want something to happen, something to change, then measurement has to be timely.

Imagine saying to staff once a month: “You had 35 late trains last month.” All you would achieve is a shrug of the shoulders. Instead, train operators monitor the lateness of trains 24/7 and phone calls are made to the team manager who made the train late, making it clear that better performance is required.

To get a change, a CEO needs to focus on the critical success factors and act on the KPIs (activities that are happening now) that will align the appropriate behaviour.


6. Do not use the lead (performance driver) or lag (outcome) indicator split

I have lost count the number of times I tried to understand the lead/lag indicators argument, until I realised my difficulty in understanding was due to flawed logic.

Many KPIs are simultaneously lead and lag indicators.

Instead of lead/lag, I recommend looking at measures either as a past measure (last week/last month), current measure (yesterday’s or today’s activities – the here and now) or a future measure (commitments made in the future, such as the date of the next visit to key customers and the number of CEO recognitions planned in the next week or next fortnight).



5 Comments


Comments
IshfaqIs-haq

David,

Having beeen involved in many KPI / Reporting projects for organisations across various sectors, I think it''s important to remember that in the current environment most if not all CEO''s want to know the risks that are inherent in their short, medium and long term strategies and their business plans.

As an example, financial numbers such as Free Cash Flow / Interest payments will in effect become a KPI. Although it doesn''t meet your characteristics above. It is these sorts of financial metrics that will generate a lot of attention and management may well be remunerated based on managing this type of risk.

In summary, when creating executive dashboards for organisations you need to get the right balance between ''real'' KPIs as you describe in your article and the holistic metrics that management really need to focus on. taking a purist approach and getting hung up on terminology with clients would be a mistake.

May 18, 2012 8:46 AM
Comments
RajeevJain

David has done an excellent job at presenting the issues faced by most organizations in adopting a scorecard in a very succinct manner. It is important to realize that each industry and organization is different - and there is no cookie cutter approach to adopting business measures. A few thoughts I would like to add:

1) Measures are not fixed for the life of the organization - they should be dynamic and be changed as business changes

2) As suggested by David, the measures must be linked to critical success factors. But in addition, they should also be linked to organizational objectives. There is an assumption that the two are always aligned, but in any given year that may not be true

3) I am a little surprised by the number of measures for Results indicators and Performance measures suggested (80) - in my view they seem to be too many for a senior management team to monitor. That may be a more acceptable number across the organization as one starts to cascade the Key measures to lower levels. Also, one needs to realize the larger the number of measures - larger the cost of collecting and that information. A quick and efficient way to report on the measures is critical, or the information will be too late for effective action.

4) Lastly, I do not agree with the point about the leading/lagging. What is a leading indicator? It is an indicator that helps us to predict the future performance. For example, if the backlog is on a down trend, then our revenue will also be going down eventually. It is important for the management to have such indicators to provide them an advance warning about their business.

May 15, 2012 7:34 PM
Comments
Karen Percent

Great article!

Mar 30, 2012 10:41 AM
Comments
Lee Hawthorn

Hi David,

This is a great article.  One of my colleagues was lucky enough to get along to one of your courses and he was invigorated after it.   This is an interesting adaptation of the BSC.

One question I have regarding measures.   Sometimes it''s not possible to measure the things that really need measuring.  How do you recommend to minimise the risk in this situation that the company ends up measuring what they can, with the result being the non-measured entities drop off the radar?  This is more of a a theoretical question, however, I think it has practical consequences in a large organisation.

Regards.

Feb 5, 2012 3:42 PM
Comments
Paul Durant

Shortly after joining a mid-sized life insurance company in 1973 I was asked to create comparative monthly operation indicators. These indices were to tie sales and internal operations to our quarterly statements. Fortunately, because we were publicly held, these indicators were not released to outsiders and not reviewed by our auditors. In today''s

wacky accounting environment I doubt these numbers could be as aggressive as they were.

Feb 2, 2012 7:32 PM
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FOUR ACTION ITEMS

Start marketing the need to run a workshop to clarify the organisation’s critical success factors.

Have a common understanding of the definition of a KPI and its characteristics within the organisation.

All measures should be vetted for a damaging “dark side”, an unintended consequence.

Limit your measures to the 10/80/10 rule: Ten KRIs, up to 80 RIs and PIs, and 10 KPIs in an organisation.