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Michael Taplin
Michael Taplin
realkpis.com is the home of The KPI Bible and offers the lowdown on KPI modeling

Corporate Dynamics Ltd
Principal Consultant

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Three steps to make KPI management work better.

Posted over 8 years ago

This article starts a short series focused on the challenges faced by every organization that attempts to improve its performance management. It examines the reasons that well-intentioned effort can produce so little result. It offers ways to find a solution.
The universal problem is that overcoming these challenges is hard work. This is a necessary condition, because if it was easy every business would have done it, and there would be no reason to pursue excellence. Finding and creating competitive advantage is never going to be easy, but the payoff for good KPI based management is huge.

When David Galvin of Motorola started the 6 Sigma TQM program he said “This is a race without a finish line; some may people find that intimidating but I find it exciting.” Once you start on a KPI model of your business you will use it for so many purposes that it becomes part of your search for new strategies and it will change to reflect each change in structure. The model will always be a work in progress.

The challenges we face in embedding KPIs into the heartbeat of our organisations are:
1. How to select the real KPIs, for your organization
2. How to create a KPI system.
3. How to get people to use the KPI system to improve performance.

Let’s look at the nature of the first challenge to find a solution. I will explore the second and third in subsequent articles.

Selecting the real KPIs.

KPI Library subscribers frequently ask for guidance on how to select the “most important KPIs” for their industry or business.
In my view this is the wrong question to ask. After all, the word KEY in key performance indicator means that all KPIs are important; they are all drivers of performance.
There are many performance measures, but only a few of them are real drivers of profit, powerful levers of progress and performance. By this I mean that a small change in a KPI exerts or predicts a large change in overall performance.

We can attempt to select them from a list of KPIs, all of which are relevant to our industry. The runs straight into the benchmarking problem; everyone is chasing the same targets.

As mining companies know, the relative position of every mine in the world can be plotted on a global cost curve using the same performance measures. Most of the measures are fixed by geography or geology and nothing managers can do will change this. Because every miner knows this, hopefully before they start digging, these measures are not a source of competitive advantage. They are not KPIs, because there is no leverage.

The global paper business works the same way. Paper mills are big operations and very large, very long-term investments. The drivers of cost are not only well known, performance data for most paper mills around the world is shared with the industry. Everyone knows the input cost performance for their mill and how it compares globally. Net cost of power per tonne of paper is an example of one these performance indicators, but it is driven largely by mill design and thermodynamics; there is little managers can do to influence short term performance.
There is no solution to our challenge to be found here.

A unique KPI model solves the KPI selection problem

A KPI model starts as an exercise in thinking. This is the first hard bit. No technology is needed.
Get your group together for about three hours. Take a large sheet of paper and pencils, so that you can erase errors and blind alleys.
Get the group to make a list of answers to the question “How to you know if you have had a good day?” The answers are likely to be KPIs so pin the list up as a point of reference.

Start with the DuPont formula: Return on funds = net profit margin x asset turns

Now tease your business apart using a single question “What drives net profit margin?” That is easy, but it gets harder as you dig deeper into the operational structure of the business.
You are likely to find yourself asking at some point in the discussion, “What drives the number of sales transactions” and “What drives the cost of selling?” This will be different for every business, because every business has a different sale process..

Draw a diagram of your KPI model as a set of labeled boxes, so that you can put in real numbers and define the formula that links the boxes. Your numbers will be operating ratios, some of them with a $ number in the ratio.

If you would like a demonstration of how this can work you can download a PDF file of a Powerpoint presentation from bizlearn.biz. There is no charge. You can also view a video demonstration of a working spreadsheet model that illustrates the thinking approach you need when you want to use a model to solve a strategy problem.

You can test the degree of leverage of a performance measure by changing a number deep in the model and following through the effect all the way to Return on Funds. Now you can decide what is a KPI, and compare it with your list. A small change in a performance indicator that generates a large change in business performance is a KPI for the related function.

Some KPIs are counterintuitive; that is they do not make sense at first sight. Others are unexpected. I warn against rejecting them out of hand. They could indicate an error in the model or the algorithms that drive it. If you check for errors and find none, you should examine the logic of your business system. You may have discovered something important that is hidden from competitors.

In fact, the best discoveries from a KPI model are those that run counter to the current accepted wisdom or practice in your industry..
The effort to build your own KPI model is always rewarded with new insight about what is important.

The next article in this series will deal with the problem of creating a KPI system. In the meantime, you should try this. You have nothing to lose and you will probably discover something important.

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