In response to yesterday's post on key performance indicators, a long time reader of this blog wrote to me as follows:
I’m not sure the average reader (one who may not have similar experiences to mine) will appreciate it as much as they should. If you can give concrete examples of why KPI’s are important (where things went wrong without monitoring them, or they helped somebody “pull up on the stick” in time), you will have a couple of very good posts.
If you can explain the process of determining KPIs in a manner that can be understood and implemented by your readers, you will have an OUTSTANDING series.
I am going to follow the reader's advice and do a series of posts on key performance indicators (KPI). First I am going to talk about how to determine KPIs and then in a subsequent post I will tell some war stories about KPIs and how they saved the day or accurately predicted the demise of a company.
KPIs basically report on the growth drivers of revenue and the productivity related to key expenses to produce revenue. KPIs are not a rehash of the income statement and frequently rely on information not on the income statement. To determine the KPIs you first must understand the growth drivers for revenue in the business. To restate from a previous post on growing your business, there are five possible revenue growth drivers:
- New Accounts (manufacturing)
- New Locations (retail, restaurants)
- New Subscribers (websites, social media)
- New Distribution Outlets (consumer products, business equipment)
- Sales Force (business services)
Most businesses rely on only one of these drivers as the critical success factor for growth in revenue, although occasionally two factors may be important. In my experience many companies do not understand the real growth driver in their business or do not analyze the driver to a sufficiently granular level. Perhaps an example will illustrate.
Let's suppose we are starting a business services company and we are selling Xerox machines to busineses. The sales force is the key growth driver and what we need to understand is the productivity of the sales force. The KPIs I would use are shown below:
Weekly by Salesperson
- Customers contacted last 30 days
- Customer meetings
- Customers sold
- $ Value of machines sold
- Average $ value of machines sold
- $ Value service agreements sold
- Average $ value of service agreements
I would also include the following month-to-date information by salesperson:
- $ Value of machines sold and monthly budget
- $ Value service agreements sold and monthly budget
These 11 pieces of data allow me to track each salesperson weekly. I can see their prospecting, their meetings and their close ratio. Looking at the dollar values allows me to determine if they are going to make budget and the averages allow me to see if they are selling inexpensive machines or working to make their budget. For a sales force you have to use weekly data because two weeks of bad performance is sufficient to identify a problem at the salesperson or sales manager level and by the third week you should be taking corrective action.
Each month I would also calculate the customer acquisition cost by adding up all the costs for each sales person (salary, commission, benefits, car, phone, support materials, etc.) and dividing that total by the number of customers sold. Comparing this number to the average gross margin per customer would show me the productivity of the salesperson and whether a salesperson was contributing to EBITDA.
If I were running a steel manufacturing plant, the growth driver would be accounts but I might also monitor the sales people. For the account KPIs, I would be looking to understand the trend in repeat orders (given that it is not common to get a one off order), as shown below:
Weekly by Account (or top 50 accounts individually)
- Orders $ (and vs budget)
- Average order $ last 4 weeks
- Average order $ last 13 weeks
- Tons (and vs budget)
- Average tons last 4 weeks
- Average tons last 13 weeks
- $/ton (and vs budget)
- $/ton average last 4 weeks
- $/ton average last 13 weeks
In this analysis I am trying to see the trend in revenue in order to spot changes in the economy (or a sector--autos) and whether a particular type of client is a better customer (in order to re-direct the sales force). Given the high fixed costs in steel manufacturing, I am particularly concerned about any negative effects on sales (which would include possible changes in tactics by a competitor). For the same reason I want to monitor the trends in tonnage. Price per ton allows me to determine how my pricing may be affecting sales and whether any changes in sales mix are having a positive or negative effect on revenue.
The example from the steel factory also makes clear another important point. KPIs should help you to monitor key business risks, such as high fixed costs, customer acquisition cost (social media sites) and customer attrition (subscriber based businesses such as telecom).
KPIs should also be used to monitor the performance of large, current assets. For example, in retailing you can not look just at inventory turnover. You need to monitor "open to buy", discounts and markdowns taken and expected delivery dates for additional merchandise. The KPIs, therefore, match up with all the tools you have to manage inventory (the critical current asset).
Next post I will dig up some war stories and discuss the Rule of Two.