As I have written in previous articles, not every metric for business or processes is a KPI. Too many IT systems and too many companies define a departmental goal as a Key Performance Indicator, creating unnecessary friction among other departments or areas of the company.
By using a weighted index, you significantly reduce, and in some cases eliminate, the competing requirements.
As part of a continuing effort on using key performance indicators for building a strategy focused organization, I offer the following illustration:
Fictitious Company ABC Inc. KPI Example
Let’s take a simple but very common example of how Key Performance Indicators are misused in business. Using some very generic and simple numbers to illustrate the problems with all of these “goals” being called Key Performance Indicators, we look at widget company ABC Inc.
ABC Inc. has what they call a “KPI” metric for Production throughput of 100 units. The production manager is given a goal to boost that metric to 110 units for a 10% increase in productivity. The company also uses this metric to measure production and provide bonus incentives.
ABC Inc. has current on-hand inventory of $1,000.00, and they likewise want to reduce inventory carrying costs by 10% or to $900.00. Again, the company measures and provides incentives for warehousing based on how much they reduce on-hand inventory.
Production and inventory management face immediate conflict. If either of those areas gets out of sync, it can create a bit of a mess. After all, you are trying to increase production throughput while pressuring inventory control to reduce stocks. Now, let’s look further.
ABC Inc. has a delivery department that is provided incentives to ship orders complete and correct the first time. Now, shipping and production experience conflict.
Because production is narrowly provided incentives for throughput, they naturally try to optimize their scheduling to ensure greatest throughput– not necessarily the best process for fulfilling customer orders. Production scheduling, customer service, inventory management, and shipping are now all in conflict because their “KPI” measures clash. Because inventory management has stock levels driven down, there is insufficient stock for effective production builds. Production suffers and delivery struggles to ship full trucks, so you incur additional freight, shipping, and handling costs.
KPI Analysis for Success
Unfortunately, this scenario is common throughout business all over the world. Businesses all too often have these competing goals, where companies (and even software vendors, consultants, etc.) provide incentives and call them key performance indicators.
The fictitious company illustration could be extended to any number of process areas of any business in the country. The idea is that if everything is a KPI, then you create unnecessary competing demands, and in some cases mutually exclusive requirements that cannot be fulfilled.
Many times, one department meets its goals, but a dependent department in the same process chain does not. For example, if production meets throughput requirements but inventory management is unable to reduce on hand stock, you could end up in an inventory buildup problem. Production capacity is increased without an improvement in stock reduction. Production may increase capacity by producing the easier products that do not line up well with customer orders, and then shipping gets backed up. Or shipping/customer service and inventory management may drive production requirements and then reduce production throughput, meaning that while the orders that get shipped are complete, far fewer orders are shipping and revenue is dropping.
A KPI Index Is the Answer to the Metrics and Goals Many Call Key Performance Indicators
As you can see from these examples, a weighted index of each of these measures combined into a single KPI is more meaningful. If bonuses or incentives are paid on the overall increase in the indexed KPI rather than the discrete departmental goals (other than possible merit awards), you are more likely to create interdepartmental cooperation.
Let’s say as a business you have a low backlog but high inventory carrying costs. You may wish to weight each of the departmental goals accordingly. This way, you are still moving toward improvements in each area but also focusing attention on the areas that matter. In this example, you may wish to weight your on hand stock and 100% order fill rate higher than your production throughput. By doing this, you are providing the correct index for the overall business needs.
By using the index and tying pay for performance programs to the index rather than a discrete departmental measure, you allow the company to pull together in the same direction. Instead of having disjointed and even conflicting goals, each area automatically pulls together to push the overall KPI index higher. If full truck deliveries are weighted higher than inventory reduction and production throughput, all areas focus on that issue together. However, since they are also measured together, and since their measurement also contributes to the overall KPI score, these departments try to find ways to achieve their own goals, still keeping an eye toward the higher scoring area(s). This encourages more teamwork and innovative process thinking rather than the silo focus that departmental goals create. In other words, creating an indexed KPI also creates cooperative dependencies among departments.
By using indexes and weighting them according to the importance to the business, you are directing your company’s energy meaningfully. You may also wish to craft and communicate a policy that the weighting for each area will be revisited and may change either quarterly or annually, depending on business needs and circumstances.
Keep in mind that if your KPI(s) are used for any type of pay-for-performance program, you should communicate reasonable expectations of weighting changes. Without that clear communication and expectation setting in the beginning, you will quickly lose your employees’ trust and undermine your KPI initiative.
