To fly a large jetliner a pilot needs more than 3-4 indicators to get you safely to your destination…
You are about to board a flight. It is a large Boeing 747. You glance inside the cockpit. (Okay, okay, imagine it is pre-9/11).
You see the pilot has taped over all the dozens and dozens of gauges, lights, and dials. There are only three he is focused on.
What do you do?
You turn on your heels and rapidly exit the aircraft.
Running a Business is Like Flying a Plane
A business is much like flying an airliner. A businessperson needs more than a few financial indicators.
The challenge with financial indicators (and they are, of course, critically vital) is that they are the measurement of a result. And you cannot change the result; it is too late.
Activities that we measure that have an impact on the result you desire are called Leading Indicators. They are like advance warning signals of things to come. You can take corrective actions to change them, and the results – hopefully – will change.
A Business Example
Now, let us look at a business example….
You have a goal for a certain sales target.
To keep it simple, we will look at four Key Performance Indicators that are Leading Indicators to reach your goal. We will choose one from each of four areas of your business – (1) Finance, (2) Operations, (3) Customers, and (4) Team.
Number One (Finance Area) is repeat business. How often, on average, do your customers come back each month.
Number Two (Operations area) is on-time delivery. This will be a powerful leading indicator of how well you are doing and may impact sales volume.
Number Three (Customer Area) is customer satisfaction as measured by customer surveys after each transaction. If the score is high this will have an impact on the number of referrals you will receive, as well as repeat business.
Number Four (Team Area) are employee satisfaction surveys measured weekly. An unhappy Team may lead to unhappy customers and thus lower sales.
Of course, one of your KPIs is sales, yet this is a Lagging, or results based, KPI. You can stare at your sales figures all day long and yet not know what to do to make them grow. To do that you need to track the key activities that are impacting sales.
How Many KPIs Should You Track?
A paper published in 1956 was called “The Magical Number Seven, Plus or Minus Two” talked about the limitations of the human brain to contain and process more than seven bits of data.
Well, since 1956 we have had Executive/Business Dashboards. We do not need to contain in our head all the business KPIs we may be measuring.
Okay, so what is the “right” number. Current thinking is somewhere between ten and twenty. This is more than the seven as written about in 1956, yet not so many that you cannot make informed decisions to attain your business goals.
Four Main Areas for Your Key Performance Indicators
As mentioned above your business KPIs should be grouped into four main categories – (1) Finance, (2) Customers, (3) Operations, and (4) Learning/Growth (or Team).
About 3-4 per grouping is enough, with a few more in the financial area. You will track both Leading and Lagging Indicators.
Here are some examples you can track:
- Sales and Gross Profit by Product Line (tells you what products/product lines are the most profitable)
- Break-Even Sales (total sales required to cover all your fixed costs plus a profit)
- Days to collect receivables on average (measures efficiency of converting sales on credit to cash)
- Cash-Flow (where did cash come from and what was it used for)
- Days in inventory on average (measures how quickly inventory is converted to cash)
- Return on Equity
- Current Ratio (measures liquidity)
- Conversion rate (percentage of leads converted to customers)
- Customer satisfaction score (how customers rate you will be a major leading indicator of future results)
- Referral rate (are new customers coming from referrals – the best source for new business)
- Average transactions per customer (repeat business is the lowest cost for new business, as it is existing customers who are coming back to buy more)
- Average sale per customer (the amount people pay on average per sales transaction)
- On-time deliveries (leading indicator of future results)
- Error rate for a manufacturer (will cause customer problems, or higher costs per transaction)
- Machine Output per machine (down time will result in lower sales)
- Productivity per Team Member (higher costs per transaction arise when productivity is low)
- Percentage of wages to sales (a leading indicator of possible lower productivity or sales volume issues)
- Team satisfaction scores (as measured by check out forms done weekly)
- Team turnover
- Education/training costs invested per employee.
- Ranking of Team members by customers
You Get What You Measure
Remember, you get what you measure. If you choose the wrong things, you might get the wrong result.
Here is an example. Let us say you want higher sales. However, your mission statement is to fulfill on what your customers want and maintain them for life.
What you measure is the average sales value per salesperson. And you reward them for their results. Higher average sales mean higher commissions and bonuses.
Your salespeople may end up pushing sales on your customers that work in the short term, yet have the customer feeling used and unappreciated, and they might leave. This obviously works against your Mission Statement.
Attach a Key Performance to a Team Member
Each KPI must be owned by a Team Leader and each person on her/his Team. Holding people accountable for their numbers will make the KPI an active measure, not passively watched by the company with no actions taken.
Here is an example. In the trucking industry it is common to have greater than 100% turnover of truckers.
Wow! Imagine that? How do they cope?
Let us say you have a human resource manager responsible for the truckers in a company that has historically experienced 90% turnover.
You give her a Target KPI of 70% turnover. She will be evaluated and rewarded on her ability to attain this 70% KPI.
What is she now thinking about all the time?
How to motivate her truckers to keep them happy and employed with this company. This consumes her thinking all day. And her actions will line up with things that will make her truckers stay and not want to leave.
Of course, she will have a budget to work with as well. (This is how you manage conflicting motivations, or she could overspend to attain her goal of 70% or less turnover.)
Think about what your goals are for the next 1-3 years. Create KPIs that will help you define and act on problems before the problem becomes too big or chronic.
Delegate the ownership of those KPIs to individual managers in your company.
Track your results weekly in some cases and monthly for others.
Meet with your Team to discuss the numbers and take corrective action.
Make sure you have many Leading Indicators so that corrective action can be taken quickly.
Thanks for reading…
** This blog is based on the thinking of a book called The Balanced Scorecard by Robert Kaplan and David Norton