Understanding Key Performance Indicators

1. To demonstrate how an organization is progressing towards its goals by measuring the performance of key processes.
2. To provide detailed knowledge about the operation of key processes, where improvements can be made and what resources are required to do so.
3. To drive a performance culture where managers and employees are motivated to make targeted improvements in performance.

There is no standard blueprint or template for determining KPIs as they differ widely between industry sectors and individual organizations. However, for KPIs to be effective, they should reflect an organization’s key drivers.[4] For example:

• A restaurant may identify the percentage of income that comes from repeat business as a KPI.
• A university or school may focus on the student graduation rate or success in finding employment after graduation as a KPI.
• A company producing high volume, low cost goods might focus on production line speed as a KPI.

KPIs should not be used in isolation, but rather as a core component of a wider system of organizational performance management. They form an integral aspect of many performance measurement scorecards[5] and dashboards.

What Should KPIs Do?

Confusion often arises over what appropriate KPIs should constitute. True KPIs should satisfy each of the following characteristics:[6]

• Key: KPIs should be restricted to elements that are ‘key’, i.e. the critical drivers which are fundamental to the success or failure of the organization in achieving its goals.
• Performance: KPIs must clearly measure performance, and be easily quantifiable to allow for detailed analysis and comparison.
• Indicator: KPIs also need to highlight progress towards, and differences between, set goals and actual results, so that improvements can be identified and prioritized.

The KPI Pyramid

Organizational KPIs should be linked to departmental and individual KPIs. Linking KPIs to the performance agreements of employees creates a sense of accountability and allows individuals to track their progress and contribute towards achieving those KPIs which are under their control.

A KPI pyramid can be established using a top-level approach. As shown in the diagram below, the highest level KPIs should be designed to measure the key drivers which will enable the organization to reach its strategic goals. Moving down the hierarchy, these should be linked to departmental, team and individual level KPIs which support overall objectives.

SMART targets are often used to assign accountability for delivering KPIs.[7] For example, an organizational KPI may be to improve customer satisfaction. This can be translated into a SMART target (e.g. for the production department) by setting an error reduction rate of 10% per quarter. This will have a noticeable impact on the number of customer returns. This target can then be built into team members’ performance agreements, thus creating a link between individual contribution and organizational objectives. By creating quantifiable targets, performance can be measured in terms of a minimum acceptable threshold, good performance and exceptional results. This informs strategic decision-making about when, where and how to take action.

Why Do KPIs Matter?

KPIs are important for a number of reasons:

• They are required by some compliance and legislative frameworks.[8]
• Disclosing KPI information to stakeholders and investors improves transparency and awareness of an organization’s overall performance, development and strategic position.
• They provide important information about trends, enabling early detection of problems, challenges and opportunities. This information can then inform decision-making about where, when and how to take corrective action.
• They provide employees with clear goals and a means of linking their own achievements with organizational goals.
• They can help to establish how performance compares across internal departments and against external competitors.[9]

The Importance of Frontline Manager Buy-In

It is important that the managers involved in gathering KPI information have the skills needed to support the process.[10] Using KPIs can be complex, therefore managers need:

• a broad understanding of the performance of the organization and how it is influenced by their specific area of responsibility (focus should not be limited to financial performance)
• strong analytical skills in order to understand KPI information and take appropriate action to improve operational processes
• performance management skills to define team members’ objectives, agree and monitor improvement actions

Different Types of KPI[11]

There are three main types of KPI - process, input and output:

1. Process KPIs: A KPI that measures the efficiency or productivity of an internal process of cycle. For example, product-repair time, time to deliver an order, or time to fill vacant posts.
2. Input KPIs: A KPI that measures the assets and resources an organization has invested in or used to generate results. Examples include research and development expenditure and quality of raw materials.
3. Output KPIs: A KPI that measures the financial and non-financial results of key activities. Examples include revenue, number of new customers acquired and percentage increase in employees.

The Ingredients of Effective KPIs

Selecting the right KPIs can be complex. However, effective KPIs have a number of important characteristics, which include:

• Relevance. If a KPI is not closely related to organizational strategy, measuring and acting on it will have little impact upon overall performance. For example, an organization may identify increased market share as an important strategic objective. The number of new leads generated by marketing campaigns and the volume of new business sales become highly relevant KPIs. Repeat business, whilst still important, becomes less relevant in the context of this particular organizational strategy.
• Influence. A KPI can only contribute to improved performance where the organization is able to influence its direction and outcome by changing its operations. For example, the weather affects many tourist organizations, but it cannot be influenced. However, sales growth can be influenced by the effectiveness of an organization’s operations.
• Timely. Each KPI should provide a flow of information which can be reported on in a consistent, regular way.
• Indefinite. The same KPIs are often measured over financial quarters or from year to year, so it is important that they are not confused with goals or objectives which have a specific timescale or deadline.
• Quantifiable. KPI measures should be easily quantifiable so that they can be compared objectively over a period of time. For example, sales growth may be an important KPI; therefore sales targets should be set to determine growth accurately.
• Empowering. KPIs (and particularly KPI targets) must be set appropriately so that they empower employees and promote the behaviors and actions which will lead to improved performance.

KPIs in Context

KPIs cannot operate in a vacuum. Developing a hierarchy of closely linked organizational and operational level KPIs will enable accurate measurement of each area’s performance and inform strategic decisions. It is important not to focus too rigidly on achieving KPI targets without considering the wider picture of organizational performance. Where there is too much emphasis on reaching targets, KPIs can cause stress, as well as removing the incentive for departments to work collaboratively to achieve their goals. KPIs should therefore address both the quantitative and qualitative aspects of organizational performance.

Conclusion

KPIs are one of the most over-used and little understood terms in organizational development and management.[12] However, when chosen and implemented correctly they can provide a highly accurate assessment of performance which is visible at all levels across an organization. For KPIs to be effective, they need to be chosen carefully and recorded consistently. Perhaps more importantly, the managers involved in reporting KPI information need to understand their part in the process and have the necessary skills and motivation to undertake their role effectively.

Find out More

• PriceWaterhouseCoopers have developed a comprehensive Guide to Key Performance Indicators: Communicating the Measures That Matter which provides a detailed overview and illustrative examples of how different organizations choose and report on their KPIs: available here<br/>
• For a detailed insight into how organizations use Kaplan and Norton’s Balanced Scorecard System to measure performance, see: