Key Performance Indicators (KPIs) — “Why?”

How KPIs are a foundation for broad-based business improvement decisions.

Why Are KPIs Important?

Every day, in business, people are asking familiar questions:

“So what is the goal?  And and how do my goals fit with yours?”

“What is reality in our business situation?  What are the facts needed for good business improvement decisions?”

“Are we reading the situation correctly and taking appropriate actions?”

“How can we encourage everyone in the business to work toward improved operational performance?  Every day, not just when we raise a red flag and circle the wagons!” 

And most of all:  “How do we know if we’re making real progress?”

Asking those questions is an interesting by-product of the “irrationally exuberant ‘90s.”  Like the characters in Eli Goldratt’s “The Goal,” many business managers have been asking if their staffs have a clear vision of how to use the new technologies purchased in the ‘90s.  Do they know where they are going?  Do they have a clear image of the present situation and the desired future? 

Think again about those questions.  If unanswered in any organization, could you expect it to achieve its potential?  Probably not, because large segments of the employee population would not have a clear enough mental image of the business goals to contribute to them.  In fact, the ability to continually answer those questions and adjust is a key characteristic of industry-leading companies.  Their people all know where they’re headed, and they get there faster than the competition. 

Fortunately, the answers to those questions do not need more systems expenditures.  In fact, they’re easily answered with fundamental business process measures.  Measures that some companies have refined into Key Performance Indicators (KPIs) that provide direction, a roadmap of sorts, for all their performance improvement efforts. 

The Business Goal

Jim Collins, in his recent book, “Good To Great,” chronicled how eleven companies moved from mediocrity to standout greatness.  Careful interpretation of key performance indicators was a common thread.  He used a “flywheel” metaphor to describe the collective efforts of business teams contributing to company success.  Having clearly-defined KPIs is a key to business success in itself.  It’s much easier to reach your destination if everyone knows exactly where they are headed.  And it’s much easier to hit the company’s business target if everyone knows exactly what their own course should be!

Triggers For Quantum-Leap Business Improvements

KPIs are a fundamental pre-requisite for a robust, continual improvement (CI) business culture.  Industry leaders continually develop new competitive advantages using KPIs as a springboard for broad-based improvement efforts.  A truth about competitive differentiators is that technical advances are often easily copied, so they offer limited-time advantages.  However, people-based differentiators are usually more difficult to copy so they can offer years of competitive advantage while others struggle to understand them, let alone actually copy them.  Hewlett-Packard had such an advantage for many years.  How business teams view their opportunities, via KPIs, is a foundation for high-performance business that triggers all sorts of small to large operational benefits.  Indeed KPIs enable spontaneous continual improvement throughout a business — eliminating the need for periodic revolutions that are often more disruptive than effective.

Balancing the Internal Conflicts

Some of the upstream KPIs can conflict with each other.  For example, if Inventory Turns is minimized independently, then there is a danger of causing unexpected stock-outs and lower Order Fill Rates, which may be a KPI of critical importance to customer service and satisfaction.  That kind of thinking goes into “KPI balancing processes” that need additional rules to rationalize the conflicting KPIs, that is, to achieve a practical balance between them with balancing methods that everyone clearly understands. 

An example of balancing the conflicts and developing meaningful KPIs is in a case study at the end of this article.

The Language of Success

There is a saying that goes “If you don’t measure it, then you probably won’t improve it.”  It’s been proven over and over by industry leaders practicing process management, statistical process control, Six Sigma and the other techniques that gained mainstream acceptance with the advent of the Quality movement in the early ‘80s.  And it’s easy to see in any business culture.  If performance measurements are liberally sprinkled throughout their daily conversations, then they are actively involved in performance improvement efforts.  It’s part of their expectations for their business culture.  And they’re all clear about the KPIs they’re monitoring to see if they’re making progress.  At that point “it’s in the walls,” as a shrewd business observer once said, and operational improvement seems to happen almost spontaneously throughout the organization.

Impact on Quality of Work Life (QWL)

In recent years, business complexity and speed have had negative affects on business teams.  Middle managers are especially stressed with many voicing “burn-out” concerns.  A side benefit of well-defined KPIs is a positive impact on QWL.  Peace of mind comes with just confidently knowing where to put our day-to-day efforts, based on logical performance indicators.  That one change can replace confusion and burn-out with clarity and optimism about the future.

Case Study: Cut Inventories To Increase The Shipping Fill Rate.  A “Miracle?”

If we manage X, then Y will be the result.  And, of course, if Y is important, but we don’t know what X is, then we’re in trouble.  For that reason, KPIs should be organized to clearly define the cause-and-effect operating relationships that need to be managed for best overall business performance.  How to do that is a topic for later, more detailed discussions.  But a simple example should illustrate why those cause-and effect relationships are so important.

Several years ago, a nationally-known manufacturer was having trouble filling customer orders complete and on time.  The fill rate had dropped to 86%.  Panic set in.

They had been managing inventory turns from a financial view to control the working capital investment, but the unsatisfactory shipping performance caused them to ask: “Could we improve the fill rate if we put less emphasis on inventory turns and instead increase our inventory levels to be sure there’s enough in stock to service the demand variability we normally see?”  A view from the warehouse manager was: “Where would we put it?  We’re full!”  So more analysis was needed. 

An inventory clerk asked: “Why do skid-loads of some items sit for weeks with little demand for them, while others seem to be often out-of-stock?”  A clue!  Someone else asked: “How do we decide how much safety stock to maintain for each item?”  The answer was clear:  “Two weeks for A items, four weeks for B items and eight weeks for the cats and dogs we don’t want to produce often.”  But the clarity quickly gave way to confusion when someone asked: “Why do we need that much safety stock for those items?  How do we know if that’s enough?  Or too much?”

The answers came from a new analysis of customer item demand variability.  Their ERP system didn’t have a suitable function, but a simple spreadsheet program was inserted to periodically measure the demand variability for every item and set safety stock levels to cover three standard deviations from the normal demand, equal to 99.8% of expected demand incidents. 

Then they installed a new KPI that measured the number of finished goods items below planned safety stock level each day.  From that change a “miracle” happened.  The entire organization began to sub-consciously focus on “safety stock compliance,” production schedules were occasionally adjusted, stock-outs disappeared and the fill rate soared to 99% in just two months.  Meanwhile the finished goods inventory level dropped by 23% from $22 million to $17 million.  And they had just begun to use the new tool to fine tune the inventory management routines further.

The Awesome Power of Cause-and-Effect KPIs

The previous “miracle of low inventories and high shipping service is a simple illustration of the power of strategically-defined KPIs.  If you express the key causal factors behind your major business goals, then you can measure them to keep attention focused on them for improvement.  Amazingly, you often don’t even have to tell people to work on them.  People just naturally “do what the boss measures.”  Just be sure you’ve picked the right ones.  The wrong ones can easily cause undesirable results!

Good Luck!

The Cumberland Group

For additional information call Rainmakers at 847/251-3327