What is a Key Performance Indicator? Examples and How to Set Them
What is a key performance indicator? We're breaking down everything you need to know and how to get started today.
Before we had the weather on our phones and TV’s, if we wanted to know the temperature outside we had to check the old thermometer hanging up on the back porch. Knowing how hot or how cold it is outside helps you choose the right clothes so that you can be at your very best. That’s similar to how Key Performance Indicators work — they measure a specific element of an organization. Not only that, they measure its success, and ultimately they let companies know what specific activities need improvement. In other words, they answer the question, ‘Are we achieving our business objectives?’
There’s no magical formula for selecting the right KPI’s to set for your business. Every organization has different priorities. What works for one company may be completely irrelevant to another. KPI priorities even vary across the different divisions of a company — the folks over in finance are mostly concerned with how everything affects the bottom line. While the sales department’s number one goal is sell, sell, sell. Everyone has separate targets, but KPI’s help drive the ship towards those targets.
Why Use KPI’s
KPI’s are like the GPS unit of a business. It’s a data driven construct that lets you know if there’s a road block ahead and if you should take another route. They monitor the trajectory of a business and inform managers and stakeholders of its progress.
KPI’s empower business owners and managers to quickly pivot inside of fiercely competitive and evolving market conditions. It’s a way to stay ahead of the game — affect the market before it affects you.
When defined properly they also work wonders on employee morale; clear, concise and understandable goals are easily absorbable by employees. It’s what motivates people to ‘buy in.’
How to Set Good KPI’s
When setting KPI’s you want to check off a few boxes. Below are some characteristics you should be aware of:
- Unaffected by Extraneous Circumstances – Well defined KPI’s aren’t affected by variables outside of the company’s control.
- Quantitative – They have a numerical value. (i.e. we sold 100 units this month).
- Derived from Data – They’re based on data which helps frame company goals (i.e., our new product upgrade has increased revenue, bringing our marketing costs closer to 20%).
- Directional – Much like a thermometer, they let you know if things are heading in a positive or negative direction. (i.e., our customer base has increased in each of the last three years).
- Applicable to The Nature of Your Business – They are tailored to your specific business model and industry; a common mistake is trying to use cookie cutter KPI’s.
- Communicated to Your Entire Company – Everyone within the company who has an impact on a particular KPI is well informed, and understands its importance.
- Informs Decision-making – They reveal what processes are working and not working; they inform you what to build upon or what to change.
KPI’s should be viewed as a succinct vessels of communication to the company. You’re packaging goals in a model that everyone can understand and push towards, ultimately allowing everyone to get on the same page and synergize towards a common target.
Examples of KPI’s
It’s extremely important to remember that when you’re setting KPI’s you have to design them based on your specific needs. No two companies are the same, and your performance goals should be unique to your company.
- Profits – This is a bit of an obvious one, but it still falls under the category of KPI. High profit margins usually means you’re heading in the right direction. Keep in mind, profit KPI’s can be separated by net and gross incomes.
- COG (cost of goods) – Analyzing production costs with everyone involved will help you define markups. Identifying fluctuations and anomalies in COGs will also prevent decreases in profit margins.
- Assets & Liabilities – Understanding your monthly liabilities and how that balances against your current assets will help departments establish intuitive budgets.
- Forecast Vs. Revenue – Any good financial analyst or even accountant should be able to forecast your revenue based on historical data. However, those numbers usually won’t be exact, and that’s a good thing — analyzing the differences between forecasted revenue and actual revenue can provide significant performance insights.
- DSO (Day Sales Outstanding) – DSO is the average amount of days it takes to receive payment after you’ve made a sale. The formula is:
- DSO = Accounts Receivable / Total Value of Credit Sales Sales x The Number of Days in The Time Period Measured.
- Your goal should be to collect payment as quick as possible so that cash flow remains high and operations remain smooth. Typically companies will monitor this monthly, quarterly and annually.
- CPA (Cost Per Acquitision) – Most commonly used to evaluate the effectiveness of marketing, research and accessibility, CPA is a highly valuable measure that lets you know the average amount you spend on earning a customer’s business. Setting this as a major KPI will make your company more efficient at turning leads into customers.
- LTV (Customer Lifetime Value) – This is the metric cousin of CAC, and they’re often used in conjunction. Setting this as a KPI allows you to identify the avenues which lead to quality customers. In other words, you want customers who are going to be loyal, and provide you with more value over a lifetime, than quick one time buyers.
- Customer Churn Rate – A high churn rate is not good. This is the percentage of customers who don’t make a repeat purchase or cancel a service. However, measuring negative values such as churn rate provides powerful insight towards improving customer loyalty.
- Number of Customers – It may be one of the more obvious KPI’s, but don’t underestimate the power of frequently analyzing the peaks and troughs of total customer numbers.
- Customer Satisfaction – This is a major one. Depending on your company setup, you can dive deep into customer satisfaction and analyze a multitude of specific areas. i.e., customer retention following initial purchase, customer review averages, survey results, repeat purchases, referrals, and more.
- NPS (Net Promoter Score) – This takes customer satisfaction one step further by illustrating the relationship between customer satisfaction and long term revenue growth. By collecting customer data through emails, surveys and reviews you can determine how potential referrals can scale up business from month to month.
- Here’s a common NPS structure. On a scale of 0 to 10: How likely are you to refer us to a friend?. Customers who respond with 9 to 10 are considered ‘promoters’, 7 to 8 are ‘passive’, and below 6 are ‘detractors’. NPS is calculated by subtracting the percentage of customers who are Detractors from the percentage of customers who are Promoters.
- Customer Service – It’s tough to create a perfect customer service model right out of the gate. It’s an ongoing process, built through trial, error, and feedback. Setting these KPI’s and monitoring progress can help you build industry leading customer service. A common example is analyzing support ticket numbers (new tickets, resolved tickets, and resolution times).
- Turnover – Measuring turnover on a quarterly basis can help you improve employee morale, which will in turn have an impact on your entire company.
Problems with KPI’s
There are some metrics that KPI’s simply cannot accurately quantify. While employee morale can be affected, there’s no reliable way to put a numerical value on it. Surveys and exit interviews are a common way to gather information, but those usually don’t tell the whole story. Therefore, spending a lot of time on employee morale related KPI’s can be problematic.
Another common problem is: when a company lives and dies by KPI’s their employees may fall victim to a one track mind — they will only see in ‘measurements’, and work quality may end up suffering.
It’s also important to make sure that you invest time in KPI’s that actually have a valid correlation with reaching major company goals. For example, let’s say you spend a year focused on increasing customer service. At the end of the year customer satisfaction is through the roof. However, due to the nature of your business your sales and profitability haven’t increased at all. That’s a lot of time spent, not making money.
Some will argue that KPI’s are no longer relevant, or that they simply end up being too expensive, time consuming and complicated for businesses to stay on top of. For some companies there is some truth to this. But at the end of the day, what you get out of KPI’s, is what you put in.
So what should we put into KPI’s?
If communication is low, chances are your KPI practices will suffer. Monitoring performance is all about communication and employee buy-in.
Maybe you’re just dipping your toes into the KPI waters for the first time, or maybe you’ve been using them for a while and aren’t seeing results. In any case, the most important things to remember is you need a tailored approach. Identify what performance indicators need regular monitoring and attack them strategically.
Don’t over do it either. You may alienate employees by forcing them to look at the company through only one type of lens — numbers.
Most importantly, don’t dilute your company’s overall goals by spending time on irrelevant measures. Profitability is almost always the biggest goal. Keep your KPI’s on the prize!