Performance measurement is failing organizations worldwide, whether they are multinationals, government departments, or not-for-profit agencies. Measures are often a random collection prepared with little expertise, signifying nothing. KPIs should be measures that link daily activities to the organization's critical success factors (CSFs), thereby supporting an alignment of effort within the organization, in the intended direction.
I see this alignment as one of the major goals of management. However, poorly defined KPIs can cost the organization dearly. Some examples are: measures gamed to benefit executives' pay, to the detriment of the organization; teams encouraged to perform tasks that are contrary to the organization's strategic direction; costly measurement and reporting regimes that lock up valuable employee time; and a six-figure balanced scorecard consultancy assignment resulting in a dysfunctional balanced scorecard.
A poll conducted during my webcasts came up with the following results, as shown in Exhibits 18.1 and 18.2. There is a move to limit the number of KPIs with just over 70 percent saying they have less than 20 KPIs, and to report them promptly with 45 percent reporting KPIs 24/7, daily or weekly. These trends are highly desirable as I will explain in this chapter.
KPIs and balanced scorecards are also failing because management is not aware of the many myths surrounding performance measures and the balanced scorecard. Just like six centuries ago, when many thought the world was flat, mankind was blind to the realities that are there to see on closer observation. We are blindly applying old thinking on how we measure, monitor, and improve performance. Let us now look at some myths surrounding performance measures which I feature in my KPI book.1
Every performance measure can have a dark side—a negative consequence or unintended action that leads to inferior performance. Well over half the measures in an organization may be encouraging unintended negative behavior. KPIs are like the moon; they have a dark side. It is imperative that before a measure is used, the measure is:
Throughout the world, organizations have been using the term KPIs to refer to all performance measures. No one seemed to worry that they have not agreed on a common definition of what a KPI actually is. Thus, measures that were key to the enterprise were being mixed with measures that were badly flawed.
Let's break the term down. Key means key to the organization. Performance means that the measure will assist in improving performance.
From research I have performed in diverse industries and as a byproduct of writing my book, Key Performance Indicators—Developing, Implementing and Using Winning KPIs,2 I have concluded that there are four types of performance measures. These four types are discussed in a subsequent section.
It is a myth that the primary driver for staff is money, and that an organization must provide financial incentives to achieve great performance. Recognition, respect, and self-actualization are more important drivers. In all types of organizations, there is a tendency to believe that the way to make KPIs work is to tie them to an individual's pay. But when KPIs are linked to pay, they can create key political indicators (not key performance indicators), which often leads to a manipulation of the measures to enhance the probability of a larger bonus.
KPIs should be used to align staff to the organization's critical success factors and show how teams are performing 24/7, daily or weekly. They are too important to allow them to be manipulated by individuals and teams to maximize bonuses. KPIs are so important to an organization that performance in this area is a given, or as Jack Welch says, “a ticket to the game.”
There will not be a reader of this book who has not, at some time in the past, been asked to come up with some measures with little or no guidance. Performance measurement has been an orphan of business theory and practice. While writers such as W. Edwards Deming, Wheatley and Kellner-Rogers, Gary Hamel, Jeremy Hope, and Dean Spitzer have been pointing out the dysfunctional nature of performance measurement for some time, it has not yet permutated into business practice.
Performance measurement is worthy of more intellectual rigor, in every organization, on the journey from average to good and then to great performance.
I firmly believe that there is not a financial KPI on this planet. Financial measures are a quantification of an activity that has taken place, and we have simply placed a value on the activity. Thus, behind every financial measure is an activity. I call financial measures result indicators: a summary measure. It is the activity that you will want more or less of. It is the activity that drives the dollars, pounds, and yen. Thus financial measures cannot possibly be KPIs.
Financial measures will always be used to measure the performance of a group of teams working together. However, they will never pinpoint the problem, or what went well, as they are a result indicator. When you have a pound or dollar sign in a measure, you can always dig deeper for the drivers of performance, the activities you want more or less of. Sales made yesterday will be a result of sales calls made previously to existing and prospective customers, advertising campaigns, product quality and reliability, amount of contact with the key customers, and so on. I group all sales indicators expressed in monetary terms as result indicators.
For over 20 years, the four perspectives listed in Kaplan and Norton's original work3 (Financial, Customer, Internal Process, and Learning and Growth) have been consistently reiterated by them and their followers. I recommend that these four perspectives be increased by two more perspectives, and that the learning and growth perspective be reworded as “innovation and learning” (see Exhibit 18.3).
FINANCIAL RESULTS Asset utilization, sales growth, risk management, optimization of working capital, cost reduction | CUSTOMER FOCUS Increase customer satisfaction, targeting customers who generate the most profit, getting close to noncustomers | ENVIRONMENT AND COMMUNITY Employer of first choice, linking with future employees, community leadership, collaboration |
INTERNAL PROCESS Delivery in full on time, optimizing technology, effective relationships with key stakeholders | STAFF SATISFACTION Right people on the bus, empowerment, retention of key staff, candor, leadership, recognition | INNOVATION AND LEARNING Innovation, abandonment, increasing expertise and adaptability, learning environment |
EXHIBIT 18.3 Suggested six perspectives of a balanced scorecard
Source: David Parmenter, Key Performance Indicators: Developing, Implementing, and Using Winning KPIs, 3rd Edition, copyright © 2015 John Wiley & Sons, Inc. Reprinted with permission of John Wiley & Sons, Inc.
Regardless of where the lead/lag indicator labels came from, they have caused a lot of problems and are fundamentally flawed. Many management books that cover KPIs talk about lead and lag indicators; this merely clouds the KPI debate.
I believe we need to dispense with the terms lag (outcome) and lead (performance driver) indicators. At my seminars, when the audience is asked “Is the late-planes-in-the-air KPI a lead indicator or a lag indicator?” the vote count is always evenly split. The late plane in the sky is certainly both a lead and a lag indicator. It talks about the past, and it is about to create a future problem when it lands. Surely this is enough proof that lead and lag labels are not a useful way of defining KPIs and should be counted among the myths of performance measurement.
Key result indicators replace outcome measures, which typically look at past activity over months or quarters. PIs and KPIs are now characterized as past, current, or future measures (see Exhibit 18.4).
Past measures are those that look at historic events—activity that took place last week, last month, last quarter, and so on. PIs and KPIs are now characterized as past-, current-, or future-focused measures. Current measures refer to those monitored 24/7 or daily (e.g., late/incomplete deliveries to key customers made yesterday). Future measures are the record of an agreed future commitment when an action is to take place (e.g., date of next meeting with key customer, date of next product launch, date of next social interaction with key customers). In your organization, you will find that your KPIs are either current- or future-oriented measures (see Exhibit 18.4).
KPIs are current- or future-oriented measures as opposed to past measures (e.g., number of key customer visits planned in the next month or a list by key customer of the dates of the next planned visits).
Most organizational measures are very much past indicators measuring events of the last month or quarter. These indicators cannot be and never were KPIs.
In workshops, I ask participants to write a couple of their major past measures in the worksheet shown in Exhibit 18.5 and then restate the measures as current and future measures. Try this exercise among a group of employees in your organization. Ask them to please take five minutes to restate three measures used in the organization.
Past measures | Current measures | Future measures |
(Last week/fortnight/month/quarter) | (24/7 and daily) | (Next day/week/month/quarter) |
Number of late planes last week/last month | planes over 2 hours late (updated continuously) | Number of initiatives to be commenced in the next month, months two and three to target areas which are causing late planes |
Date of last visit by key customer | Cancellation of order by key customer (today) | Date of next visit to key customer |
Sales last month in new products | Quality defects found today in new products | Number of improvements to new products to be implemented in next month, months two and three |
EXHIBIT 18.5 Past, current, or future measures to replace lead/lag indicators
Source: David Parmenter, Key Performance Indicators: Developing, Implementing, and Using Winning KPIs, 3rd Edition, copyright © 2015 John Wiley & Sons, Inc. Reprinted with permission of John Wiley & Sons, Inc.
The lead/lag division did not focus adequately enough on current or future-oriented measures. Most organizations that want to create alignment and change behavior need to be monitoring what corrective action is to take place in the future.
Monitoring the activity taken now about the organizing of future actions to occur will help focus staff on what is expected of them. Future measures are often the fence at the top of the cliff. They are in place so we do not have to report inferior performance (the body at the bottom of the cliff). In other words, future measures help make the right future happen. Here, in Exhibit 18.6, are some common future measures that will work in most organizations.
Future innovations | To be an innovative organization we need to measure the number of initiatives which are about to come online in the next week, two weeks, and month. |
Future sales meetings | To increase sales we need to know the number of sales meetings which have already been organized/scheduled with our key customers in the next week, two weeks, and month. |
Future key customer events | To maintain a close relationship with our key customers a list should be prepared with the next agreed social interaction (e.g., date agreed to attend a sports event, a meal, the opera, etc.). |
Future PR events | To maintain the profile of our CEO we need to monitor the public relations events that have been organized in the next one to three, four to six, seven to nine months. |
Future recognitions | To maintain staff recognition the CEO needs to monitor the formal recognitions planned next week/next two weeks by the CEO and SMT. |
Key dates | Date of next product launch, date for signing key agreements. |
EXHIBIT 18.6 Examples of future measures
Source: David Parmenter, Key Performance Indicators: Developing, Implementing, and Using Winning KPIs, 3rd Edition, copyright © 2015 John Wiley & Sons, Inc. Reprinted with permission of John Wiley & Sons, Inc.
All these future measures would be reported in a weekly update given to the CEO. Although CEOs may let a couple of weeks pass with gaps appearing on these updates, they will soon start asking questions. Management would take action, prior to the next meeting, to start filling in the gaps to ensure they avoided further uncomfortable questioning. The differences in the four
measures and the past, current, and future time periods are further explained in Exhibit 18.4. KRIs are summaries of past performance, principally monthly trend analysis over 18 months. KPIs focus on activity in the past week, yesterday, and today, and that planned for the next week and the next two weeks. PIs and RIs will be heavily weighted to the past; however, we do need at least 20 percent of measures to be current- or future-focused.
They assume that a measure is either about the past or about the future. They ignore the fact that some measures, particularly KPIs, are about both the past and the future. I recommend that we dispense with the terms lead (performance driver) and lag (outcome) indicators. We should see measures as either past, current, or future. Current measures refer to those monitored 24/7 or daily. I also include yesterday's activities, as the data may not be available any earlier (e.g., late/incomplete deliveries to key customers made yesterday).
Future measures are the record of a future commitment when an action is to take place (e.g., date of next meeting with key customer, date of next product launch, date of next social interaction with key customers). In your own organization, you will find that your KPIs are either current- or future-oriented measures.
This was probably the most damaging process used in the balanced scorecard approach. It assumed that by analyzing a measure such as “return on capital employed” you could break it down into myriad measures relevant to each team or division. It also assumed that each and every team leader, with minimal effort, would arrive at relevant performance measures. Kaplan and Norton ignored the crucial facts that team leaders and the senior management team need to know about the organization's critical success factors and the potential for the performance measure to have a “dark side,” an unintended consequence.
I believe all measures are sourced from the organization's critical success factors and that it is better to find measures, from the ground up, at the team level within the operation, level 4 in Exhibit 18.7.
Other myths (discussed in my KPI book4) include:
Every performance measure has a dark side, an unintended negative consequence. The importance of understanding this dark side and the careful selection of measures should never be underestimated. Well over half the measures in an organization may be encouraging unintended behavior. The frequency with which performance measures are set to fail, is at best, naïve or, at worst, corrupt management. As Dean Spitzer says, “People will do what management inspects, not necessarily what management expects.”5 How performance measures can go wrong can be illustrated by two examples.
There needs to be a new approach to measurement—one that is done by trained staff, an approach that is consultative, promotes partnership between staff and management, and finally achieves alignment with the organization's critical success factors and strategic direction.
Dean Spitzer, an expert on performance measurement, has suggested the appointment of a chief measurement officer who would be part psychologist, part trainer, part change agent, and part project manager. The chief measurement officer would be responsible for setting all performance measures, assessing the potential dark side of a given measure, abandoning broken measures, and leading all balanced scorecard initiatives. I have included more information about this role in the attached PDF material to this chapter.
Over the last 25 years, I have come to the conclusion that there are four types of performance measures, which fall into two groups, as shown in Exhibit 18.8.
Two Groups of Measures | Two Types of Measures in Each Group |
Result indicators reflect the fact that many measures are a summation of more than one team's input. These measures are useful in looking at the combined teamwork but do not help management fix a problem, as it is difficult to pinpoint which teams were responsible for the performance or nonperformance. | Result indicators (RIs) Key result indicators (KRIs) |
Performance indicators are measures that can be tied to a team or a cluster of teams working closely together for a common purpose. Good or bad performance is now the responsibility of one team. These measures thus give clarity and ownership. | Performance indicators (PIs) Key performance indicators (KPIs) |
EXHIBIT 18.8 Four Types of Performance Measures
The common characteristic of key result indicators (KRIs) is that they are the result of many actions. They give a clear picture of whether your organization is traveling in the right direction and at the right speed. They provide the board or governing body with a good overview of progress on the organization's strategy. These measures are easy to ascertain and are frequently reported already to the board or governing body.
The fact that key result indicators are called KPIs creates a problem that many organizations do not appreciate. They cannot understand why performance ebbs and flows and appears to be outside the control of the senior management team. Key result indicators that are reviewed typically on monthly or quarterly cycles will only tell you whether the horse has bolted and are thus of little use to management, as they are reported too late to change direction or shut the gate, so to speak. Nor do they tell you what you need to do to improve these results.
KRI measures that have often been mistaken for KPIs include:
Separating KRIs from other measures has a profound impact on the way performance is reported. There is now a separation of performance measures into those impacting governance (up to 10 KRIs in a board dashboard, as shown in Chapter 8) and those RIs, PIs, and KPIs impacting management. Accordingly, an organization should have a governance report (ideally in dashboard format) consisting of up to 10 KRIs for the board, and a series of management progress reports at various intervals during the month, depending on the significance of the measure.
The result indicators (RIs) summarize the activity of more than one team and they provide an overview of how teams are working together. The difference between a key result indicator and a result indicator is simply that the key result indicator is a more overall and more important summary of activities that have taken place.
As already mentioned, financial indicators are a result indicator as they are a result of activities often undertaken by a number of different teams. Financial indicators are useful, but they can mask the real drivers of the performance. To fully understand what to increase or decrease, we need to look at the activities that created the financial indicator.
Result indicators (RIs) could include:
Performance indicators (PIs) are those indicators that are nonfinancial (otherwise they would be result indicators) that can be traced back to a team or teams working closely together, who share the same measures. The difference between performance indicators and KPIs is that the latter are deemed fundamental to the organization's well-being. Performance indicators, though important, are thus not crucial to the business. Performance indicators help teams align themselves with their organization's strategy. Performance indicators complement the KPIs; they are shown on the organization, division, department, and team scorecards.
Performance indicators (PIs) could include:
What are KPIs? KPIs represent a set of measures focusing on those aspects of organizational performance that are the most critical for the current and future success of the organization. KPIs are rarely new to the organization. Either they have not been recognized or they were gathering dust somewhere.
The late-planes KPI worked because it was linked to most of the critical success factors for the airline. It linked to the “delivery in full and on time” critical success factor, namely the “timely arrival and departure of airplanes,” it linked to the “increase repeat business from key customers” critical success factor, and so on.
It is interesting that Ryanair, an Irish low-cost airline, has a sole focus on timeliness of planes. Ryanair knows that this is where it makes money, often getting an extra European flight each day out of a plane due to their swift turnaround and their uncompromising stand against late check-in. They simply do not allow customers to get in the way of their tight schedules.
The late-planes KPI affected many aspects of the business. Late planes:
From extensive analysis and discussions with over 3,000 participants in KPI workshops, covering most organization types in both public and private sectors, I have been able to define seven characteristics of effective KPIs (see Exhibit 18.10).
Nonfinancial | 1. | Nonfinancial measures (not expressed in dollars, yen, pounds, euro, etc.). |
Timely | 2. | Measured frequently (e.g., 24 by 7, daily or weekly). |
CEO focus | 3. | Acted on by the CEO and senior management team. |
Simple | 4. | All staff understand the measure and what corrective action is required. |
Team based | 5. | Responsibility can be tied down to a team or a cluster of teams who work closely together. |
Significant impact | 6. | Major impact on the organization (e.g., it impacts more than one of the CSFs and more than one balanced scorecard perspective). |
Limited dark side | 7. | They encourage appropriate action (e.g., have been tested to ensure they have a positive impact on performance, whereas poorly thought through measures can lead to dysfunctional behavior). |
EXHIBIT 18.10 Characteristics of KPIs
Source: David Parmenter, Key Performance Indicators: Developing, Implementing, and Using Winning KPIs, 3rd Edition, copyright © 2015 John Wiley & Sons, Inc. Reprinted with permission of John Wiley & Sons, Inc.
For the private sector, key performance indicators that fit the characteristics I have proposed could include:
For government and nonprofit agencies, some additional key performance indicators could be:
My KPI book provides many examples of measures and illustrates the difference between these four measures.
How many measures should we have? How many of each measure type? What time frames are they measured in? To answer these questions, I devised, more than 10 years ago, the 10/80/10 rule.
I believe an organization with over 500 FTEs will have about 10 KRIs, up to 80 RIs and PIs, and 10 KPIs, and these are reported in different time intervals, as shown in Exhibit 18.11. These are the upper limits and in many cases fewer measures will suffice. For smaller organizations the major change would be a reduction in the number of RIs and PIs.
Types of performance measures | Characteristics | Frequency of measurement | Number of measures |
1. Key result indicators (KRIs) give an overview on the organization's past performance and are ideal for the board as they communicate how management have performed (e.g., return on capital employed (%), employee satisfaction (%), net profit before tax and interest). | These measures can be financial or nonfinancial. Does not tell you what you need to do more or less. A summary of the collective efforts of a wide number of teams. | Monthly, quarterly | Up to 10 |
2. Result indicators (RIs) give a summary of the collective efforts of a number of teams on a specific area (e.g., yesterday sales ($), complaints from key customers). | 24/7, daily, weekly, fortnightly, monthly, quarterly | 80 or so. If it gets over 150, you will begin to have serious problems. | |
3. Performance indicators (PIs) are targeted measures that tell staff and management what to do (e.g., number of sales visits organized with key customers next week/next two weeks, # of employees' suggestions implemented in last 30 days). | These measures are only nonfinancial. Staff know what to do to increase performance. Responsibility can be tied down to a team or a cluster of teams who work closely together. | ||
4. Key performance indicators (KPIs) tell staff and management what to do to increase performance dramatically (e.g., planes that are currently over two hours late, late deliveries to key customers). | 24/7, daily, weekly | Up to 10 (you may have considerably less) |
EXHIBIT 18.11 The 10/80/10 rule
Source: David Parmenter, Key Performance Indicators: Developing, Implementing, and Using Winning KPIs, 3rd Edition, copyright © 2015 John Wiley & Sons, Inc. Reprinted with permission of John Wiley & Sons, Inc.
Reporting up to 10 KRIs to the board or governing body is entirely logical. We do not want to bury them in too much detail. A board dashboard can easily be designed to show these KRIs, along with summary financials all on one fanfold (A3) page, as shown in Chapter 8. For many organizations, 80 RIs and PIs will at first appear totally inadequate. Yet, on investigation, you will find that separate teams are actually working with variations of the same indicator, so it is better to standardize them (e.g., a “number of training days attended in the past month” performance measure should have the same definition and the same graph).
When we look at the characteristics of KPIs one will see that these measures are indeed rare and that many organizations will operate very successfully with no more than ten of them. Kaplan and Norton6 recommend no more than 20 KPIs. Hope and Fraser7 suggest fewer than 10 KPIs while many KPI project teams may at first feel that having only 10 KPIs is too restrictive and thus increase KPIs to 30 or so. With careful analysis, that number will soon be reduced to the 10 suggested, unless the organization is composed of many businesses from very different sectors. If that is the case, the 10/80/10 rule can apply to each diverse business, providing it is large enough to warrant its own KPI rollout.
It has no doubt been witnessed by many readers that too many measures will cloud issues. I believe the 10/80/10 rule is a good guide, as it appears to have withstood the test of time.
To assist the finance team on the journey, templates and checklists have been provided. The reader can access, free of charge, a PDF of the suggested worksheets, checklists, and templates from www.davidparmenter.com/The_Financial_Controller_and_CFO’s_Toolkit.
The PDF download for this chapter includes: