What are they?
A key performance indicator (KPI) is a measure used to reflect organisational success or progress in relation to a specified goal.
The purpose of KPIs is to monitor progress towards accomplishing the strategic objectives that are typically communicated in a strategy map.
KPIs are typically included in a reporting scorecard or dashboard that enables top management, the board or other stakeholders to focus on the metrics deemed most critical to the success of an organisation.
Financial KPIs are generally based on income statement or balance sheet components, and may also report changes in sales growth (by product families, channel, customer segments) or in expense categories. Non-financial KPIs are other measures used to assess the activities that an organisation sees as important to the achievement of its strategic objectives. Typical non-financial KPIs include measures that relate to customer relationships, employees, operations, quality, cycle-time, and the organisation’s supply chain or its pipeline. Some prefer to use the term ‘extra-financial’ rather than non-financial, suggesting that all measures that contribute to organisational success are ultimately financial. In addition to financial and non-financial, other common categorisations of performance indicators are quantitative versus qualitative; leading or lagging; near-term or long-term; input, output or process indicators etc.
The critical element in developing KPIs is determining what is important or ‘key’ to the organisation. Operational measures are also important – they can be termed as just ‘performance indicators’, or ‘PIs’, to distinguish them from KPIs.
Developing KPIs should be part of an overall strategic management process that connects the overall mission, vision and strategy of an organisation, and its short- and long-term goals, to specific strategic business objectives and their supporting projects or initiatives. Understanding the organisation’s value drivers and the core activities and competencies that underpin its value proposition is an important first step in this process.
Value creation map template
Source: Marr, B. (2008) Managing and delivering performance, Elsevier Ltd, Oxford
What benefits do Key Performance Indicators provide?
KPIs can improve strategy execution by aligning business activities and individual actions with strategic objectives. Well-designed KPIs can provide a means for management and the board to monitor core activities of the business rather than simply outcome measures of financial success. Integration of financial and non-financial KPIs can contribute to a greater focus on long-term success rather than short-term financial performance.
Questions to consider when implementing Key Performance Indicators?
- Do we understand our value drivers and core activities?
- What KPIs do we need? What performance questions do we need to answer?
- What mix of financial and non-financial measures do we need?
- What customer, human capital, operating, supply chain or pipeline measures do we need to monitor?
- Are there other key measures that are important drivers of our business, such as R&D, patents developed?
- Are there leading indicators that we can develop from available data?
- Can we collect meaningful data in a cost-effective manner for each of the desired measures?
- Are our existing management information systems adequate to support the collection, analysis and reporting process?
|Actions to take / Dos||Actions to Avoid / Don'ts|
This article, based on interviews with finance executives from Maersk Energy and International Flavors & Fragrances (IFF), discusses the importance of developing relevant KPIs and the role of the finance function in delivering more insightful information to manage performance.
Albert Birck, the head of performance management for Danish energy company Maersk Oil, describes the organisation’s thought process for developing KPIs as follows: ‘Every time we discuss or design something for performance management, we assess the options to see whether they create value, are transparent, actionable (relevant, meaningful, able to influence), timely (which is more important than ‘perfect’) and forward-looking.’
Taking this approach and making good use of their performance management technology solution has enabled the finance function to take Maersk from managing by ‘gut feeling’ to having high-quality analytical insights.
Roger Blanken, CPA, vice president of finance – supply chain for IFF, talks about his company’s use of ‘economic profit’ and weighted-average-cost of capital (WACC) in planning strategy. He also explains how IFF looks at high-level indicators such as GDP, consumer prices and exchange rates – factors that impact on their commodity-based business.
Making economic profit the primary measure of profitability has raised the quality of discussions within the company when making investment decisions.
Related and similar practices