The KPI is a common buzzword in business, but what is it, and more importantly, how do you use it to manage your business? Used properly, Key Performance Indicators, or KPIs, allow a business owner and management team to evaluate the overall health of a business, identify areas for corrective action, and make decisions on important opportunities.
One of the most common challenges we hear from business owners is their lack of information to make decisions. The brilliant business mind Peter Drucker summed things up by saying, “what gets measured gets managed.” Very sage words, but easier said than done. Too often, business owners are stuck between having too little information, perhaps just a P&L, or so much data that it is impossible to comb through and determine what truly matters in their business. The answer to this problem is a well-designed set of KPIs.
So where do you start? In every business, there are primary drivers that determine the difference between success and failure. An organized summary of these drivers is often referred to as a dashboard. And that dashboard is an overall gauge of the health of the business. It is not very different than the dash in your car. A good KPI system serves like a maintenance light, indicating that there is something, if not multiple things, in your business that need a tune up. And if ignored for too long, the wheels can start to fall off.
There is no “right” number of KPIs. Two is too few and twenty is probably too many. On average, somewhere between six and twelve is probably a good target, but what is more important than the number of indicators is the quality of the indicators. I would ask two key questions about any KPI: can you trust the underlying data, and do the measurements allow you to confidently take action that will result in a change in your business? If the answer to both of those is yes, you almost certainly have a good KPI.
Key Rules of Thumb
• The business environment is constantly evolving; so, too, should the KPI dashboard. When reviewing, not only ask what the dashboard is telling you, but ask if it is telling you something no longer relevant, or are you possibly missing something relevant altogether? When first building a dashboard, establish a framework and then regularly refine it over time. KPIs may fall off and others may be added. Goals can, and should, change as well.
• Every business is unique; so, too, should be the dashboard or menu of KPIs and the goals for each measurement. You can certainly rely upon industry data and company history. However, a company that is twice the size of another will almost certainly have different realistic targets. And if you have a new product line compared to two years ago, are historical numbers a good barometer for the future?
• Have regular meetings to review the KPIs. For some metrics, that may mean weekly, but in most cases, at a minimum, a monthly review is necessary. Review and determine what the metrics are telling you about the business.
• Ensure a balanced view. Monitor KPIs that look backward (i.e. Units Sold) as well as forward looking (i.e. Opportunities in Pipeline). Look not only at the Income Statement, but the Balance Sheet as well (i.e. Days Cash on Hand). What about productivity? For a manufacturing company, it can be very valuable to track how many labor hours it takes to manufacture a widget.
• The KPIs need to be able to be calculated without too much effort. If your team must spend 5 hours collecting the data to calculate one metric, you should ask yourself if that is the right metric.
• Keep things in context. In a business that has any cyclicality for example, the measurements may change materially on a monthly basis and so, too, should the goal. Think of the gas gauge in your ca. Being on empty with 40 miles to drive is a lot different from being on empty pulling into a gas station. For a seasonal manufacturing company, inventory levels might build up during slow sales seasons, but if the labor hours required to manufacture that inventory goes up, labor many not be working efficiently, chewing up profit and cash at a time when you need to conserve most.
• TAKE ACTION! If all indicators are positive, but the pipeline is bare, that recent success could be short-lived. Having this information allows you to place additional focus on sales. If margins are shrinking due to market conditions, it may be time to cut spending and conserve cash.
When done correctly, KPIs can provide a CEO with the confidence to make key decisions and the visibility to avoid pitfalls that await in the future.