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What Is A KPI? (A Definition, & 3 Questions Answered)
Understanding what a KPI is and how to use it can help your organization execute on your strategy more appropriately.
One of the questions we're asked regularly is, "What is a KPI?" We've found that the clearest way to explain a KPI—or, key performance indicator—is to break the concept down into three levels:
- An indicator is simply a measure used to capture a measurement in your business. For example, you might measure how many hours your employees work, the number of sick hours used, or the amount of paper used. It’s important to note that indicators are very likely meaningless, because they likely don’t impact your business. For example, does it really matter how many hours all of your employees have worked over the last week? It might only if you use those hours to bill clients—but otherwise, there’s nothing actionable you can do with that bit of data.
- A performance indicator tracks a measure related to your organization’s performance. For example, manufacturing companies may choose to examine performance indicators around the number of raw materials sourced, the number of defects per manufactured lot, or the number of steps in your manufacturing process. But a performance indicator is missing one thing: It’s criticality to the business. And that’s where a key performance indicator comes in.
- Key Performance Indicators (KPIs) are the subset of performance indicators most critical to your business at the highest level of your organization. KPIs are used to help you measure your progress toward achieving your strategic goals. In our experience, the most effective leadership teams track fewer than 25 measures that cut across the organization’s four perspectives: financial, customer, process, and people.
Why is it so critical to select the right KPIs?
Simply put, KPIs drive organizational performance.
You’ve likely heard it said that “what gets measured gets managed”—we’ve found this to be true. If you’re focused on your KPIs, your staff will be focused on changing the appropriate behaviors. On the opposite side of the coin, if you choose the wrong KPIs, you run the risk of driving unintended behaviors.
Let’s say you manage a casual food business. One of your goals is to conserve food—so you choose a KPI related to serving smaller portions. An unintended consequence of this action could be angry customers who would rather dine elsewhere. Even though you’ve technically met your goal, the result shows you went after the wrong KPI. A better thing to measure may be about how optimal is your fresh food ordering process so you have to throw less away (with the KPI being “amount of food waste”).
There are two rules for selecting the right KPIs:
- KISS: You’ve likely heard the acronym, “Keep it simple, stupid.” This phrase rings true for KPIs. Make it as easy to understand as possible, so your employees will be clear about what they need to do.
- SMART KPIs: SMART stands for specific, measurable, attainable, realistic, and timely. Is your KPI all of these things? Take a look at this article for specifics on how to improve in each area.
Take advantage of the opportunity to make smarter financial decisions with this list of 68 financial KPIs.
What KPI selection mistakes should you watch out for?
There are two common missteps made during the selection process:
- Choosing KPIs you’ve always measured. Measuring the KPIs you’ve always measured may not take into account any changes in your customer’s behavior that could help your company grow. For example, let’s go back to our fast casual restaurant example. If you’re only measuring the speed at which you can bring people through the ordering line simply because that’s what you’ve always measured, you may be missing an opportunity for growth that could be brought about by doing something new, like integrating an online ordering system.
- Choosing KPIs that are the easiest to measure. Basing your choice on simplicity rather than strategy won’t, in most cases, help you accomplish anything. Assess every KPI based on its relationship to your overall goals. For example, are you measuring the number of customers you get each day because that KPI will help you achieve a strategic goal, or simply because it’s easy to track?
Do you know how to select the right type of KPI?
Every KPI should help measure a clearly-defined goal you’re trying to achieve. But some of your measures will be lagging indicators (i.e. outcome KPIs) and some will be leading indicators (i.e. driver KPIs). Here’s how you differentiate between the two:
When you don’t know what activity will drive better results, you’ll need to select an outcome KPI, known as a lagging indicator. For example, if you aren’t sure what activities would drive higher sales at your restaurant, you may want to measure “sales” and then try different, innovative activities that could make an impact—like running off-hours promotions, offering new meal choices, etc. Once you figure out what has the biggest impact, then you could look at measuring sales during promotions or sales of new menu items.
When you do know what KPI will drive better results, you’ll need to select a driver KPI, known as a leading indicator. For example, if you know that sales have slowed because you’re unable to take orders more quickly, you may be able to drive people to order in advance or hire additional staff to take orders during your busiest times. These activities would drive the behavior you want.