Danger of Leading Indicators

22 12 2009

UPDATED 12-23, 2009:  Boston.com story about home sales – seems like we have stories with divergent viewpoints.  Good example of how a single version of the truth depends upon the story teller…

CNN Opening Paragraph: NEW YORK (CNNMoney.com) — After surging 10% in October, sales of existing homes jumped again in November, growing 7.4% compared with October to an annualized rate of 6.54 million units, according to the National Association of Realtors. (full article)

Boston Globe Opening Paragraph: WASHINGTON—Sales of new homes plunged unexpectedly last month to the lowest level since April, a sign the housing market recovery will be rocky and heavily dependent on the generosity of Uncle Sam. (full article)

Read each…Ahh, the politics of spin, or is it the spin of politics of spin.

November saw a healthy jump in home sales.  The good news is that home sales and housing starts are usually very good leading indicators about the health of the economy.  Yet the bad news, in this case we have a potentially baked number.   The market is being artificially inflated with both lower interest rates and a government subsidy for first time home buyers.  What makes this worse is we have created a situation where we know less – we know a number improved, but we have no understanding if the economy is better.

CNN Story on November Home Sales

This is one of the fears about designing the right KPIs.  We want to find the perfect KPI, or create a list that tries to include everything.  What we need are a few KEY indicators to trigger the right conversations about what actions (business levers to pull) to take or not take.   We also need to discuss performance and action in a holistic manner and not get caught in panic mode because one indicator seems to be below expectation.  We also do not want to trigger an action to artificially improve a number.

For example…Days Sales Outstanding (DSO) can be used as a measure of customer satisfaction.  The interpretation is that people pay the bills of the people they like first.  If you are able to shrink the number, then you at least have an indication that customers are generally happier than they were last month.  If the Marketing VP were compensated on Customer Satisfaction and we used DSO, the VP might change the payment terms.  While we might see improvement in DSO, we are probably not seeing an improvement in Customer Satisfaction, which was the goal when we started.

As you are designing KPIs:

  • Start with your high level annual goals for the year
  • Build out a system to discuss the implications (don’t just look at the number)
  • Assign someone to write up the implications on a regular basis
  • Create a commonly understood definition of the KPI, and document it where it can be easily accessed




KPI: Overhead per Customer

22 07 2009

If you are trying to measure management improvement, how about looking at Overhead per Customer (or per transaction).  This should be a decent indicator in terms of management and overhead scalability.  If we are doing a better job of managing the business we should see some increased returns in the management function.

  • If the trend is increasing, we should be discussing the scalability of the organization.
  • If the trend is decline, is it for the right reasons?

While you are at it, you might also include cost of sales per transaction.  This one is perhaps a little more debateable in that we don’t want to artificially manage this number.  Reducing the number of sales reps, may drive down the number.  Reducing compensation plans may chase away our better sales reps.





KPI Design: Better than average

16 06 2009

In the June 1st issue of ESPN Magazine there was an interesting story about Rafael Nadal.  In the story there is a call out with some interesting facts about his play.  One of the items is his rotations per ground stroke versus the average pro.

Nadal Math Smaller
While this is fanatastic information to explain why he is better than average, what might have been more relevant to the article which is about his excellence would be to compare him versus the other top players.  What if all the top players are hitting at 5,000-6,000 rotations per ground stroke?

As we are designing KPIs and targets we need to make sure we are measuring against a relevant target, not just an industry average.





KPI Library: Profit per Employee

14 06 2009

If you are looking for a productivity or effectiveness KPI, a sure place to start is revenue per employee (unless you are in the public sector).

  • It is a straight forward calaculation
  • It is easy for every employee to get their heads around
  • It is a measure of scalability
  • It is a crtical measure for long term success
  • It triggers great conversations about the health and direction of the company

It has one primary weakness in that it is a lagging indicator.

Similar metrics to this are Revenue per Employee, Expense per Employee, Expense per Sale, Profit per Transaction, Profit per Customer.





Interesting Financial KPIs (REL Consulting)

28 05 2009

I found a few KPIs on the web that were worth discussion.  These are from REL Consulting (under solutions > key metrics).  These are both great KPIs for the CFO as well as for the organization to better understand.  

Here are a couple of initial thoughts:

  • As these are really Financial KPIs, which while clearly quite important, don’t always make good operational indicators.  Financial KPIs only make up part of the overall health of the organization.  
  • These are also lagging indicators, as are most financial metrics.  By the time these have changed, chances are we have already been through some business cycle and have potentially lost value we could have identified earlier.
  • The trend here is clearly important, as a change in any of these is clearly an alarm for their business.  These might be more monitoring type of metrics (sorry Jonathan, had to throw it in here), if the trend were to change it might indicate further analysis to define specific actions.  
  • We need to make sure we are not managing to these artificially.  Take for example, Days Sales Outstanding (DSO), this is often a proxy guage for customer satisfaction.  If marketing/sales changes payment terms just to impact this number we are doing the wrong thing (potentially).
  • Perhaps the greatest strength of these KPIs are as teaching tools.  If we are saying this is what is important as an end result, then we need to be able to communicate what they mean and how each of the individual processes, programs, and initiatives impact these metrics.  Most people in the organization don’t understand the financial outcomes with exception to revenue and perhaps margin.  HR and Finance should make this part of their training regimens to improve overall financial knowledge.
  • We also need to understand how these impact strategy.  If we are a high tech company with a priority on market share, chances are a lot of these numbers are going to slip.  Perhaps the converse is more interesting, if the market wants us to focus on market share growth, we need to be careful that these are not sacrificed to an inappropriate level.

Again, I am not saying these are anything other than great measures.  Nor am I picking upon REL as I have heard very good things about them.  But as you are designing KPIs, they need to be easy to understand, linked to strategy, balanced across functionality, and more often than not leading indicators.

Best Possible Days Sales Outstanding (BPDSO)

BPDSO is the value that achieved if all customers paid exactly to the agreed upon payment terms. Typically a business will offer more than one payment term to its customers and therefore the BPDSO takes the different payment terms offered into consideration by using a weighted average based on value of sales/revenue by payment term. This measure is often called the theoretical days sales outstanding (DSO) because in reality it is almost impossible to actually achieve as there will always be customers who pay late and other external factors hindering receipt of payments to term (e.g. banking delays, post service delays, etc.).

Cash Conversion Efficiency (CCE)

CCE looks at how efficient companies are at generating free cash flow from operations, or operating cash flow from sales revenues – how much free cash flow makes the journey through the operating cost structure of a company. While CCE is a simple metric to derive using it can provide powerful insights into the overall health of an organisation’s cash-generation capabilities.

Days Inventory Outstanding (DIO)

DIO is financial and operational measure, which expresses the value of inventory in days of cost of goods sold. It represents how much inventory an organisation has tied up across its supply chain or more simply – how long it takes to convert inventory into sales. This measure can be aggregated for all inventories or broken down into days of raw material, work in progress and finished goods. This measure is normally produced monthly.

Days Payables Outstanding (DPO)

DPO is a relative measure of a business’ outstanding payment liability. DPO measures the level of outstanding payments at the end of a month expressed in terms of the number of days payments represented by the creditor balance, i.e. the number of day’s worth of payments still outstanding. The metric is useful as it gives an indicator over time of what payment terms are being accepted and complied with within a company.

Days Sales Outstanding (DSO)

DSO is a relative measure of a business’ debtor exposure. It measures the level of outstanding sales/revenue at the end of a month expressed in terms of the number of days sales/revenue represented by the balance of the accounts receivables (i.e., the number of days worth of sales/revenue still outstanding). This measure is typically represented as a monthly trend and is important as the increase in the gap between DSO and BPDSO can be an early sign of deficiencies in the credit and collections process. When determining if the DSO of a company represents good performance, it should be compared to the company’s BPDSO. BPDSO is important as a reference point against which to compare a company’s DSO performance. A DSO of 92 may initially appear to be very high, but if the company’s BPDSO is 88, then a DSO of 92 represents a good performance.

Days Working Capital (DWC)

DWC is a measure of the cash conversion cycle that gives insight about the underlying health of a business. It is a key metric because it measures the average number of days of tied up working capital in the operating cycle. If DWC is trending upwards over time then it will have a negative financial impact on overall company profit.

Forecast Accuracy (FA)

Compares the ratio of forecast error to actual sales and is expressed in percentage terms. It shows the accuracy of the sales forecast compared to actual sales within a period of time, normally a month. Forecast accuracy typically shows better results when we are predicting demand for the next weeks as opposed to the next months, or where we aggregate the measure for a group of items. The more accurate the forecast, the easier it is to manage inventory levels across the supply chain.

Return on Capital Employed (ROCE)

ROCE is a ratio that indicates the efficiency and profitability of a company’s capital investments. The measure is important as ROCE ratio should always be higher than the rate at which the company borrows, otherwise any increase in borrowing will reduce shareholders’ earnings.

Shareholder Value Add (SVA)

SVA is a value-based performance measure of a company’s worth to shareholders. The basic calculation is net operating profit after tax (NOPAT) minus the cost of capital from the issuance of debt and equity, based on the company’s weighted average cost of capital. All working capital improvements help improve SVA.





Clarity – Pick One Voice

17 05 2009

A few months ago during the Presidential inauguration, a concept I have kicked around a bit presented itself in a vivid example.  What stuck me was all the pomp and circumstance, all the background noise.  Did I really want to hear the opening prayer, the closing prayer, all the singing, and the poetry?  No, I wanted one thing – to hear the message this President was going to deliver on how he was going to set up his presidency.  Everything else was in a way, distraction.

As organizations, how often do we set a clear and concise goals for the organization and the individuals?  How many times do we repeat what someone else just said?

When we design KPIs for the organization, do we create a single measure for a goal and use other analytics for support?  Or do we create a number of ways to view the goal?  If we create many definitions, we allow for people to pick the one they want.  Use KPI design as a way to gain clarity of a goal.  Use Scorecard design to gain clarity of purpose.





Customer Lifecycle Value

1 05 2009

Depending upon on how well your know your business, a great discussion to have somewhat regularily is whether or not the customer lifecycle value is increasing or decreasing.  To achieve this we need to know a few things…

  • How much has the customer purchased from us?
  • How long are they likely to stay with us?
  • What does it cost us to serve them?

None of these are necessarily easy questions to answer, but that does not mean we should not talk about these items. Worst case, you should at least be looking at the average revenue and cost per client and see how those are changing. They are probably pretty good indicators of lifecycle value.  If we look at the trends of our revenues, costs (COGS & SGA), and profits per customer this should certainly indicate if we are doing better or worse.

While most of us do this to some degree, we probably also throw in a great deal many more variables and business rules and end up discussing various concepts. What about once a month or once a quarter getting all the department heads together and discuss progress on only these items.





Setting Targets

23 04 2009

Setting targets for Performance Indicators should be well thought through. This should not be an exercise in looking at the historical average (unless that is specifically relevant) and then apply 10% as the desired increase. You will want to review history, but you need to understand the goal. It is also important to define the KPI clearly.

For example, let’s use the retail market’s target of sales to sales last year. Retail has traditionally looked at this on a daily basis, as well as rolled up to the week, month, quarter, and year. I have two primary concerns with this:
  • If the weather was bad, we ran a promotion, or some other contributing factor, we may not know it and are really not comparing apples to apples. Additionally, what if last year was really bad? Beating that number doesn’t do much for us. 
  • If we are reviewing this on a daily basis, we loose institutional knowledge due to the repetition. What if we miss a day? Is there any repercussion? What if we miss three days in a row? What if we miss 10 days out of 14? Were there enough days in there of good performance to hide the fact that a trend is occurring?

What would make more sense to me would be to look at this number as a rolling average, or take the total sales for the last 365 days / 365 on a daily basis. Here we can very quickly identify a positive or negative trend, as we don’t have to look at numbers that swing wildly by the day of the week. Instead of talking about  a couple of bad days, we understand that even though we had a couple of bad days, the overall trend is above the goal. We can also integrate our sales goal and show it relative to the trend line.  





Key Performance Indicators (KPIs) & Key Risk Indicators (KRIs)

6 04 2009

Key Risk Indicators (KRIs) are an interesting concept, or twist to Key Performance Indicators (KPIs).  Instead of thinking of KPI measuring performance, think of a KPI as really just an indicator that the objective is at risk.  They are really the same thing.

If your objective is to Maintain Salesforce Effectiveness, a solid indicator might be revenue per sales rep.  If our revenue per sales rep is declining, it should be treated as a trigger for a broader discussion on the objective, not necessarily the KPI.  At the same time, we will want to analyze a number of other performance indicators for a deeper, richer discussion.

We look at KRIs for example employee turnover is this not just a performance measure against the objective Retain Great Employees?

In the end though, we are just splitting hairs by calling something a KPI or KRI.  It matters far more that we have the discussion about the objective(s), than trying to build separate processes to measure subtle nuances.





Scorecards & Dashboards

16 03 2009

These are two terms that the BI world uses interchangably. The only thing they should have in common is that they both can visually display data.

Defined:

  • Scorecards are tools that help facilate discussions around strategy and operational performance management. The indicators (KPIs) should foster discussions about corporate direction, resource allocation, priorities, and initiatives. 
  • Dashboards should be used for tactical discussion triggers, like inventory orders, technical support, phone coverage, etc. 

What should be happening with these tools is a far more structured use for each (and throw in reporting as well). All too often these tools are used without discipline which leads to mulitple versions of the truth, lack of focus, red herrings, miscommunication, and ultimately a waste of time and energy.

IT and business users need to work together to better understand what each tool can provide, when that tool will be used, how it will be used, how it will NOT be used, and who should be using them.





Align to Customer Value

16 03 2009

On thing to consider in terms of developing KPIs (Key Performance Indicators) is how they are aligned to the customer’s wants.  All to often we ignore this perspective, yet it is perhaps one of the most important factors.  

For example, one of the growing cost saving tools companies use is call automation services.  “For sales, press 1.  For customer service, please hold while we test your patience.”  

Companies do this because they are measuring cost per call, or efficiency.  What the customer really wants is a convenient resolution to their call, or effectiveness.  Clearly these goals are working against each other and in most cases destroys customer loyalty and brand value.  

In the end, we need to balance costs with value, and we need to understand customer and corporate strategy.  Are we focused on customer intimacy as our core business focus, or operational excellence?  Are we measuring the business in a manner that reinforces our business model and customer value creation, or strictly by the bottom line?





Efficiency vs. Effectiveness KPIs

13 03 2009

Key Performance Indicators (KPIs) should be measures of risk to annual goals or strategic objectives.  If we can keep this list of KPIs minimal, we stand a much greater chance of keeping the organizational focus on improving key processes.

To derive these KPIs we need to understand the organizational inputs, outputs, and desired outcomes.  While this is a little academic, it is a good way to start to organize and define your KPIs. Outputs / Inputs are measures of efficiency, while Outcomes / Inputs are measures of effectiveness.  By overlapping the organizational or departmental focus we can align and define these KPIs to make sure they are driving the desired behaviors.  

Tradionally Sales and Marketing goals are to be effective, thus revenue per head, or win percentage are better measures.  While finance and IT are generally geared for efficiency withcost per order, or IT spend per target are more common.  

KPI design is far more difficult than people expect and is often unique to the environment as strategies, objectives, and priorities vary organization to organization.





External & Market Indicators

25 02 2009

One item most organizations struggle with is leveraging external indicators. Early last year, the price of gas created a chain reaction. Most companies cost of goods sold increased to where they were forced to raise their prices as their margins eroded.  

Even if we do that, we typically do not have a systematic way to incorporate the learning into a business process. What we would need is the ability to understand the external indicators, know of potential sources for the information, and work these into ongoing environmental scans.  

What is the value of understanding how the consumer price index impacts your revenues? What happens if you were able to move before your customer in terms of supply chain interruption? In some cases, this could mean millions to your top or bottom line. There are a number of organizations that knew the market was struggling in 2008, but did nothing to prepare.  And a number of those names will never be the same (GM, AIG, Circuit City, etc).

When is the last time you did a formal environmental scan, discussed the results, and put new actions into place?








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