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Google KPIs and you will quickly find lists of KPIs, organized into functional KPIs or business type KPIs. How useful are they?It is easy to develop metrics for a business. A simple metric is a number, typically an activity number or a $ number. The next level of metric is a ratio, usually of a $ number to another $ number in the classic accounting ratio ysis of financial performance. Operational performance ysis needs activity ratios, or cost per unit of activity. We are making progress with our business metrics. None of these answer the question which ratios are the real key performance indicators?The real KPIs are the ones that give us superior leverage over our return on funds. A small movement in a KPI produces a large movement in our business return.Some practitioners recommend starting with the strategy and the goal to develop a structure for the KPI list for an enterprise. Others focus on business processes in a search for efficiency. I think this can too easily miss the point and lead you down a blind alley. The search for structure is commendable but self-limiting when viewed from the perspective of what can be achieved. Intuitively we understand that structure is required, but can either of these approaches deliver what we need?Selecting KPIs for your business from a list generated by other people has two risks.1. You are likely to entrench your present business system, becoming more conservative.2. You are less likely to identify real opportunities for improvement in your business processes.One of the central ideas behind strategic thinking is the need to have a different strategy. All marketers understand the need for a discernible point of difference, in what the enterprise does, or in how it does it. Me too strategies only produce mediocre me too results. This issue is the core of the problem.If you build your KPI structure around your present strategy, or your established business process, you can only get better at implementing yesterdays strategy or process. You embed your present strategy in your organization but you have little prospect of generating a new point of difference for the business.How is a KPI model different?A KPI model is the business in microcosm, captured ultimately in a spreadsheet model. This is a form that enables you to explore the effect of a change in performance at a point (a function or a process) on the overall performance of the business. It should be a structured series of operating ratios that are linked. An operating ratio is usually a combination of a $ number to a quantity.An example that illustrates the thinking process is $ cost per sales call and order to call ratio (success rate). These two ratios combine to derive the selling cost $ per order which is probably a KPI, when you are looking at the effectiveness of your sales process, or your sales contribution.This simple example reveals a number of important factors:1. The numbers you need for this calculation are often not available directly from the accounting system.2. Your sales management records should reveal call success rates.3. Your $ numbers and the number of orders must come from the accounting system, because you should never have two accounting systems.4. Raw numbers are never KPIs, at the very least because they are not ratios.5. The relationships are defined by an algorithm.6. You can change the selling cost per order by a. reducing the number of calls needed to generate an order, probably by improving the quality of leads, b. Increasing the number of orders, by improving the competence of salespeople, c. reducing sales staff pay rates, d. Increasing the number of calls, by shortening call duration,7. The likely success strategies are quickly revealed because c and d conflict with the objective.8. When you find out what you have to spend on a and b to achieve a worthwhile improvement, you can quickly work out how an investment in training compares with an investment in improved lead quality. What is the payback time and what target needs to be achieved in a reduction in selling cost per order to make it pay.9. The best answer is far from obvious, but there is an optimum strategy for you to find. The optimum answer is the one that increases your ROFE by the greatest amount.The working relationships between different parts of the business are complex and interlinked. A cost saving in one area is often a cost increase in another. You can improve performance in one area at the expense of a reduction in performance in the next. In a process environment, you can find that one department improves its numbers by passing off costs to the next in the chain. This is a zero sum game, consuming much energy and generating more heat than light. The business loses.A primary purpose of a KPI model is to help you identify the real drivers of financial performance.You should be able to answer the question If I change X from (say) 1 to 1.5, how does it affect my return on funds employed (ROFE)? Then you can ask, What do I have to do to change X? The answer may require spending more at some other point in the business process, so you need to factor those changes into the model. Sometimes this will require investment in more efficient equipment. Now you can check your ROFE to find out whether the investment will pay off.An example from the printing industry.Printing press manufacturers compete on the basis of speed and set up time. To sell the new machines, they publish the operating parameters for new models. The decision to buy a new machine is complex because the economics of the process are changed. The effect on the finished job cost and selling price depends on whether all of the efficiencies made available by investment in the new technology are captured by changes in other aspects of the production process.I have seen large investments lead to an increase in idle time and reduction in profitability when upstream or downstream processes are not upgraded to match the new production rate off the press. In other cases, the benefit has not been captured because the market has been saturated and there was insufficient demand to soak up the new capacity. Reducing prices to increase market share led to a price war.If they had followed the impact of the new equipment through the whole process, using a detailed KPI model they would have found out about what else needed to be changed to capture the benefit of the new technology. The decision process would have changed, and the they would have been more likely to get the result they sought If your KPI model enables you to answer the question Which investment generates the greatest improvement in ROFE?, it is working for you at the strategic level.Some drivers of performance are really important, in that you get a high return from minimum effort or minimum risk. Often, having found a powerful KPI by playing what if? with your model, you have to think hard about what change in strategy is needed to make it work for the business. This is the really important bit because now you are focused on the point of difference; how to do something totally different from what everyone else is doing.A good KPI model enables you to explore different options so that you can be more confident about your strategy decision.You dont have to live in a me too world; you can strike out on your own with the help that your own KPI model offers. Good luck and happy modeling.





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