Key Performance Indicator (KPI)
Key performance indicators (KPI) are a set of quantifiable measures that a company uses to gauge its performance over time. These metrics are used to determine a company's progress in achieving its strategic and operational goals, and also to compare a company's finances and performance against other businesses within its industry.
A good KPI should act as a compass, helping you and your team understand whether you’re taking the right path toward your strategic goals. To be effective, a KPI must:
- Be well-defined and quantifiable.
- Be communicated throughout your organization and department.
- Be crucial to achieving your goal. (Hence, key performance indicators.)
- Be applicable to your Line of Business (LOB) or department.
Why measure performance using KPIs
Performance measurement using KPIs is a process that requires substantial planning and effort to achieve a successful outcome. So why implement a KPI program? Some or all of the following reasons for using KPIs will typically apply:
- To instil a performance driven culture whereby performance and its improvement are seen as a core part of a broadcaster’s principles of operation;
- Improve the quality of management decision making by providing the best information so that resources are effectively and efficiently utilized by the broadcaster;
- To identify whether the organisational strategy and milestones are on track so that stakeholders can be confident that management are working towards their objectives and for management to identify situations when objectives are not being met or need to be changed;
- Help to communicate and align strategy across the broadcaster to ensure that all the key parts of the organisation are working to achieve the same strategic goals;
- Provide transparency and accountability at both management and stakeholder level so that all key areas can be confident in the processes that they follow and understand their responsibilities in achieving organisational success;
- Assist in meeting compliance reporting requirements set by Government and regulators, for example, the quality/reliability of transmission signals and local content requirements. These may need to be reported through corporate external documents such as a broadcaster’s annual report to government; and
- Support a focus on continuous improvement which can be facilitated by tracking the progress of KPIs overtime and between both internal and external benchmarks.
Categorization of Indicators
Key performance indicators define a set of values against which to measure. These raw sets of values, which are fed to systems in charge of summarizing the information, are called indicators. Indicators identifiable and marked as possible candidates for KPIs can be summarized into the following sub-categories:
- Quantitative indicators that can be presented with a number.
- Qualitative indicators that can't be presented as a number.
- Leading indicators that can predict the outcome of a process
- Lagging indicators that present the success or failure post hoc
- Input indicators that measure the amount of resources consumed during the generation of the outcome
- Process indicators that represent the efficiency or the productivity of the process
- Output indicators that reflect the outcome or results of the process activities
- Practical indicators that interface with existing company processes.
- Directional indicators specifying whether or not an organization is getting better.
- Actionable indicators are sufficiently in an organization's control to effect change.
- Financial indicators used in performance measurement and when looking at an operating index.
Types of Key Performance Indicators (KPIs)
There are three major types of KPI within a business.
- Overall Business KPIs: These are the KPIs that the whole business is working towards. They will be broad and will be metrics which everyone in the business can identify with and understand. For example in a Software as a Service business like Geckoboard these are things such as grow Monthly Recurring Revenue (MRR) by a certain percentage each month. This is what the overall success of the business relies on.
- Departmental/Team KPIs: Whilst the whole business needs KPIs that enable them to focus on a common goal, each department or team within a business also requires KPIs that unite them around a goal. The important thing is that these departmental or team indicators feed into the overall business reaching their KPIs. For example, in Geckoboard where our focus is on growing MRR every month each department might have KPIs which are relevant to their work and help drive revenue, such as:
- Sales - Having more demos is what drives more customers and ultimately more revenue through sales. So their KPI could be to grow demos by a certain amount each month as a team.
- Marketing - Having more potential customers trialling the product each month will also drive more customers and ultimately revenue. As such, their KPIs would be about growing trial sign-ups each month.
- Customer Success - Our Customer Success team are responsible for delighting our customers. Ensuring customers don’t leave makes sure revenue continues to grow, so their KPI would be to reduce churn rate by a certain amount each month.
- Product & Engineering - Whilst for other departments it’s easy to define KPIs, by nature of the work that Product and Engineering do being more distant from revenue generation, it’s a little more challenging. However, if you break it down there are KPIs that are relevant. To support reduction of Churn, keeping our application working will ensure customers are happy, so application uptime targets could be one KPI. Also, delivering new relevant features and customers using those features successfully will help drive revenue growth. As such, target numbers of customers using features and completing tasks using those features might be other KPIs.
- Individual KPIs. These are KPIs for individuals within a business, and are often tied to individual performance appraisals. However, there is a school of thinking that tying individual KPIs to performance appraisals is counterproductive. The arguments against are that it encourages employees to fudge figures distorting the reality and also encourages competition as opposed to collaboration. However, this can be overcome, according to Stacey, by detaching KPIs and performance appraisals. Also, instead of choosing measures to judge how people have performed against each other come performance appraisal time, help people choose KPIs based on the results they collaborate to produce, and use those measures as ongoing and regular feedback in between performance appraisals to adjust and improve how those results are produced.
Characteristics of Key Performance Indicator (KPI)
From extensive analysis and from discussions with over 1,500 participants in my KPI workshops, covering most organization types in the public and private sectors, seven KPI characteristics are defined:
1. Nonfinancial measures (not expressed in dollars, yen, pounds, euros, etc.)
2. Measured frequently (e.g., daily or 24/7)
3. Acted on by the CEO and senior management team
4. Understanding of the measure and the corrective action required by all staff
5. Ties responsibility to the individual or team
6. Significant impact (e.g., affects most of the core critical success factors (CSFs) and more than one BSC perspective)
7. Positive impact (e.g., affects all other performance measures in a positive way)
Methodology for Developing Meaningful KPIs (Figure 1.)
The following methodology provides a guide through the process of developing clear objectives and key performance indicators (KPIs) to support a strategy. It describes the processes to ensure that KPIs have targets and owners. It shows how to build KPIs that provide evidence that objectives are being met, (or not!) It does not end there though. Once KPIs have been defined, they need to be presented in a way that will ensure accurate interpretation. The methodology provides examples of KPI automation that show how to link interpretation to action thus moving an organisation closer to its objectives and ultimately its strategy. The methodology has seven steps as depicted in Figure 1. below:
Figure 1. source: Intrafocus
What makes a KPI effective?
A KPI is only as valuable as the action it inspires. Too often, organizations blindly adopt industry-recognized KPIs and then wonder why that KPI doesn't reflect their own business and fails to affect any positive change. One of the most important, but often overlooked, aspects of KPIs is that they are a form of communication. As such, they abide by the same rules and best-practices as any other form of communication. Succinct, clear and relevant information is much more likely to be absorbed and acted upon. In terms of developing a strategy for formulating KPIs, your team should start with the basics and understand what your organizational objectives are, how you plan on achieving them, and who can act on this information. This should be an iterative process that involves feedback from analysts, department heads and managers. As this fact finding mission unfolds, you will gain a better understanding of which business processes need to be measured with KPIs and with whom that information should be shared.
Defining KPIs (Figure 2.)
To ensure consistency in the organization, a KPI definition sheet needs to be filled and completed for each KPI by those responsible for setting and reporting on the KPI. An example of such a sheet is shown in Figure 2. When setting KPIs, there are six common forms, each of which has its own strengths and weaknesses:
1. Absolute number, e.g., total profit. This is one dimensional. The advantage is that it’s a very clear target but it doesn’t address a specific context.
2. Index, e.g., an internationally used index, such as the United Nations' Human Development Index (HDI). This is multidimensional, but it can mask underlying individual variables.
3. Percentage, e.g., percentage of satisfied employees or customers. This is a good indicator of relative change but is sometimes misunderstood.
4. Ranking, e.g., very commonly used to rank institutions such as banks, universities or schools. The advantage is that it’s easy to understand, but definitions are often inconsistent or unclear.
5. Rating, e.g., customer ratings of a product. This is a useful measure for nominal data, but it can be biased or misused.
6. Ratio, e.g., revenue versus cost ratio. Ratio measures are much used by finance people. They are good at illustrating critical relationships, but can be difficult to understand.
Figure 2. source: EY
Challenges in Developing Key Performance Indicators
It takes considerable effort to develop a high-quality set of performance indicators. Managers and functional experts work together to propose a set of measures and to debate the relative importance of the various measures. A number of key challenges include:
- If the firm's strategy and key objectives are not clear, measures tend to focus on just financial outcomes.
- Too much reliance on financial indicators offers a very imbalanced and incomplete view on the health of a business.
- Measures deemed important by one area may not be viewed as important by others.
- If compensation is tied to key targets for the performance indicators, this introduces a conflict of interest and considerable bias into the process.
- Identifying leading indicators is a difficult process.
- The ability to accurately measure and report on the identified measures may be difficult or impossible given internal reporting system limitations.
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