What is a KPI?

A key performance indicator (KPI) is a measure reflecting how an organization is doing in a specific aspect of its performance. A KPI is one representation of a critical success factor (CSF)—a key activity needed to achieve a given strategic objective. Organizations that measure performance identify the handful of critical success factors that comprise every strategic objective.

For example, depending on a company’s strategy, the organization might have a KPI for the percentage of income the organization derives from international markets. Another KPI might be the number of customer complaints about orders filled incorrectly. Some organizations use many KPIs for all their different areas of operation. Other enterprises’ KPIs may focus on a specific area. For instance, a social service nonprofit may focus all its KPIs on the amount of aid that is granted to different entities.

Typically, each unit within a company also has a set of KPIs that supports the company’s goals. Performance data for a unit’s KPIs can be rolled up into the company’s KPIs to reflect total organizational performance in any given area being measured.

As a manager, you probably won’t participate in developing KPIs at the corporate level. However, you may be involved in creating KPIs at your unit’s level, especially if your unit was recently acquired or has been associated with a new product, process, department, or line of reporting. Regardless of your situation, you should be aware of the KPIs that are in place in your organization. With this awareness, you can appraise your group’s progress toward corporate and unit goals.

Three types of KPIs

Key performance indicators come in three types: First, process KPIs measure the efficiency or productivity of a business process. Examples include “Product-repair cycle time,” “Days to deliver an order,” “Number of rings before a customer phone call is answered,” “Number of employees graduating from training programs,” and “Weeks required to fill vacant positions.”

Second, input KPIs measure assets and resources invested in or used to generate business results. Examples include “Dollars spent on research and development,” “Funding for employee training,” “New hires’ knowledge and skills,” and “Quality of raw materials.”

Third, output KPIs measure the financial and nonfinancial results of business activities. Examples include “Revenues,” “Number of new customers acquired,” and “Percentage increase in full-time employees.” Three particularly common output KPIs that managers use include:

• Return on investment (ROI): Return on investment represents the benefits generated from the use of assets in a company, unit, or group—or on a project. ROI is helpful to top executives, finance managers, board members, and shareholders. A possible way to express return on investment is to divide net income (revenues less expenses less any liabilities, such as taxes) by total assets. ROI measures how effectively managers have used resources and can be figured as follows:

  ROI = Net Income/Total Assets

• Economic value added (EVA): EVA, popularized in the 1990s by U.S. management consultancy Stern Stewart & Co., is defined as the value of a business activity that is left over after you subtract from it the cost of executing that activity and the cost of the physical and financial capital deployed to generate the profits. In the field of corporate finance, EVA is a way to determine the value created, above the required return, for a company’s shareholders. It’s therefore useful to senior management, boards, and shareholders and other investors. EVA is calculated as follows:

  EVA = Net operating profit after taxes–(net operating assets × weighted average cost of capital)

  Shareholders of a company receive a positive EVA when the return from the equity employed in the business’s operations is greater than the (risk-adjusted) cost of that capital.

• Market share: The percentage of sales in a given industry segment or subsegment captured by your company.

All three types of KPIs—process, input, and output—generate valuable performance information. A mix of the three types ensures a comprehensive picture of your unit’s or organization’s performance.

KPIs and you

Even if your boss doesn’t require you to track process, input, or output KPIs, it’s vital that you familiarize yourself with these indicators. Why? For one thing, you may hear these terms used frequently in your organization. Also, you want to understand how your organization defines the determinants of success—for example, where your organization’s resource allocation emphasis is. Moreover, in many industries, third-party researchers (such as J.D. Power & Associates) use KPIs to track how your company measures up against the competition. If you consult such research, you’ll need to understand KPIs. In addition, these indicators can help you figure out your role in helping your organization achieve its goals. And finally, you’ll enhance your credibility and value as a manager if you can demonstrate understanding of your company’s and unit’s KPIs.

Who uses KPIs?

Managers at all levels in an organization can track key performance indicators to assess how well their groups are meeting their business objectives, whether performance is improving or declining, and how their group’s performance compares with that of other units or groups within the company and in rival organizations. Consider these examples:

• A CEO examines return on investment by division, or her company’s cash flow, by month and quarter, and compares the results with those of competitors.
• A customer service manager tracks customer service quality using surveys. If the surveys suggest that service quality is dropping, he might need to add more account representatives to improve service levels.
• A benefits administrator monitors how many claims her group has processed during the current year and compares it with the number processed in the previous year. An increase, for example, may suggest it’s time to invest in new benefits software that can speed up claims processing.
• A product development manager assesses the ratio of sales from new products to total sales. He decides that his group needs to invest more in research and development to increase the ratio.
• A human resources staffer calculates the percentage of employees who actually attend voluntary training programs offered by the company and compares the result against the targeted percentage. A drop may indicate the program is unsuccessful and can prompt an inquiry to find out why—possibly saving the company thousands of dollars in ineffective training programs.

  What You COULD Do

  Remember Darlene’s concern about how to measure her group’s performance?

  Here’s what the mentor suggests:

  Darlene should first ask Tina to clarify TopCo’s and the division’s strategies. Darlene realizes that the different ways they gauge success at TopCo work together like a dashboard, showing the state of the company. Based on her understanding of her division’s strategy, she and her group will then identify appropriate objectives (or goals) for the group. Next, they’ll work together to identify the two or three critical activities they must carry out to achieve those objectives. And they’ll translate those actions into a set of performance metrics that express how they’ll measure progress on the critical activities. Their metrics will need to reflect a mix of business results—such as sales, customer satisfaction, product innovation, best-practice sharing, staff morale, and operational efficiency. Once Darlene’s group has created metrics, they will set targets representing the division’s desired performance on each metric and begin gathering data to see how their actual performance compares with the targets they’ve set. They’ll then analyze any gaps between actual and target performance and decide how to respond.

• A communications expert reviews employee survey results to see whether workers understand the company’s corporate strategy. Lack of understanding may suggest that the company’s CEO and other executives need to make clearer presentations on strategy or need to reach employees through different channels.

If you’ve recently started in your role as manager, you may not yet know which KPIs are used in your unit or group. How might you find out? Ask your boss what measures your group has been using to track performance. If your unit has a business analyst, see if he or she would be available to discuss your unit’s KPIs and other performance metrics.