As I’ve written before 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 between 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’m offering this 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 very simple numbers to illustrate the problems with all of these “goals” being called Key Performance Indicators we will 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. This is what is measured and this is how the department is provided 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, reducing on hand inventory is what warehousing is measured on and provided incentives for.
Right away there is an immediate conflict between production and inventory management. If either of those areas gets out of synch it can create a bit of a mess. 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, 100% correct first time. Now there is a conflict between shipping and production as well.
Because production is narrowly provided incentives for throughput they will naturally try to optimize their scheduling to ensure greatest throughput, not necessarily the best process for fulfilling customer orders. Production scheduling and customer service and inventory management and shipping are now in conflict because their “KPI” measures are at cross purposes–, they have competing goals. Because inventory management has stock levels driven down there is insufficient stock for effective production builds. Production suffers while the ability to ship full trucks is also negatively impacted and you incur additional freight, shipping, and handling costs.
KPI Analysis for Success
This type of example is COMMON throughout business all over the world. It is routine in business to have these competing goals, where incentives are provided, which many companies (and even software vendors, consultants, etc.) call key performance indicators.
The fictitious company illustration could be continued 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 can not be fulfilled.
Many times one department will meets it goals and another department which is a dependent area in the same process chain will not, then you have a mess. 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 while stock reduction is not improved. 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 at 100% 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 inter-departmental 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 are 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 cause the company to pull together in the same direction. Instead of having disjointed goals which sometimes conflict with other departments each area would automatically pull together to push the overall KPI index higher. If full truck deliveries are weighted higher than inventory reduction and production throughput then all areas would focus on that issue together. However since they are also measured together, and since their measurement also contributes to the overall KPI score then these departments would try to find ways to achieve their own goals with an eye toward the higher scoring area(s). This would encourage more teamwork and innovative process thinking rather than the silo focus that departmental goals create. In other words creating the indexed KPI also creates cooperative dependencies between departments.
By using indexes and weighting them according to the importance to the business you are directing your company’s energy where it is the most meaningful. Together with this you may 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.
It is important to keep in mind that if your KPI(s) are used for any type of pay for performance program that you 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.
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