Often when I start working with business owners and management, I ask them what their KPI’s are. I’ll hear responses such as “my company’s Accounts Receivable Days Sales Outstanding”, “our backlog of open orders and pipeline of leads and proposals”, “our net profit” or “our sales trend year over year and against budget.” These are all performance measures but none of them are KPI’s; they are, in fact, Results Indicators. What’s the difference?
A performance measure is any indicator used by owners and managers to measure, report and, it is hoped, improve performance. Thus it’s critical to know that there are two types of performance measures but only one can actually be used to strengthen a business.
The first type of performance measure, Results Indicators (RI’s), report what and/or how a company has done. RI’s can be non-financial (for example, last month’s capacity utilization percentage) or financial (gross profit). Most RI’s are measured quarterly or monthly but they can be weekly or even daily. They summarize the outcomes of multiple activities. Examples include Net Sales, Gross Profit %, AR DSO, Net Profit, Employee Turnover, Inventory Turns, Customer Satisfaction Rating, and Return on Capital Employed. However, RI’s cannot be tied to a discrete activity and don’t indicate what needs to be done to strengthen performance going forward. That’s particularly true of financial measurements, which can only report outcomes or results and never indicate actions to take to improve a business.
The most important RI’s (10 or fewer) for measuring how a business has performed are Key Results Indicators (KRI’s). These are the measurements that will be shared with a Board of Directors or senior management to inform them whether their company is moving in the right (or wrong) direction and keeps them focused on the longer-term vision. An example might be Year-to-date Operating Profit compared to prior year or budget; such a measure clearly speaks to how well the company is performing and whether its performance is better or worse, and in line or out of synch with expectations. However, it doesn’t indicate what needs to be done to improve.
By contrast, Performance Indicators (PI’s) and, by extension, Key Performance Indicators (KPI’s) are measurements that point toward what needs to be done to affect performance. They have several very specific attributes.
1. PI’s are only non-financial measurements.
2. They can be tied to a discrete activity, and importantly, they can be acted on by the responsible person or group within a company (this could be a manager, a team, a department, a division, etc.).
3. PI’s are measured frequently – weekly, daily, or even in real-time; they are visible in current or real-time displays and reports so that quick action can be taken.
4. A PI also alerts (senior) management to a significant issue that allows the owner, CEO, executive or manager to contact the responsible party and determine if appropriate action is being taken.
5. Employees understand the measure and the corrective action it mandates.
6. The measurement has a significant impact on one or more of the company’s critical success factors (CSF).
7. It has a positive impact; that is, it causes no unintended negative behaviors or results and affects other performance measures positively.
8. PI’s are never historical; they are always indicators of current or future action. For example, Accounts Receivable Days Sales Outstanding (AR DSO) as of prior month-end, or past 12 months; average or trend line AR DSO, are Results Indicators. Uncollected invoices that were due for payment yesterday (current) or the number of customers with past due invoices that are to be contacted this week for payment (future) are PI’s.
Examples of PI’s include:
- Shipments yesterday that were not on-time and complete
- # of Unresolved Customer Complaints
- Forecast stock-out of any key product
- Scheduled visits to key customers and prospects in the next month
KPI’s are the 5 to 8 most important PI’s that support a company’s strategy or address a company’s critical success factors. Whereas KRI’s can be developed by the CEO/senior management for use with ownership or the Board, developing KPI’s for the company (and PI’s for the company’s various functions or teams) should be a collaborative process with the company’s employees. KPI’s should be developed by senior management after team-level PI’s are identified. Having employees and teams, departments or divisions involved helps: assure employee/manager/team buy-in; identify the most appropriate PI’s for the team/function; and assure that the PI’s for a function relate to one or more of the CSF’s for the company.
Making the effort to identify the right KPI’s for a company can give rise to significant enhancements in a company’s performance.
* With appreciation to David Parmenter, the dean of KPI’s, who articulated the principles and implementation details of KPI’s in his book “Key Performance Indicators – Developing, Implementing and Using Winning KPI’s”