In the era of big data, companies are confronted with more and more information from both their own information system and the external world. This makes steering and monitoring performance even more challenging than it used to be.
Using KPIs helps identify what works and what does not, what deserves our attention and what is less important, what are possible areas of concern and where we should set our priorities. It is important that they are reviewed regularly to make sure you are using the right ones, you report them in the appropriate form and the right cadence.
Both external analysts and company management will utilise KPIs to evaluate the company. However, there are substantial differences:
- Overall objective: While the former will want to compare a company against its peers, the latter will want to evaluate its own performance and take actions
- Focus: Analysts concentrate on results and their sustainability (if good) or room for improvement (if bad) as an indicator of top management quality, while the company’s management will want to review particular areas, evaluate certain actions and review performance also on lower hierarchies
- Type of KPIs: Analysts will focus on classic KPIs they can take out of published results or board meetings, while management has access to a much broader database and will be able to break down their analysis to a more detailed level
- Form of KPIs: Analysts will define KPIs relative to some common size measure (often they will use turnover, total assets and so on) to facilitate comparison across companies and industries. While this may also be relevant for management, this is not necessarily their top priority.
Our focus here is on KPIS as they are used from a company’s management to analyse their own performance and take corrective actions when needed. Here are three steps you need:
Step 1: Reorganise your data and define accountability.
Do not just take the data as in your reported accounts.
Suppose you are an FMCG producer and you start some consumer actions that affect the selling piece, such as an overfill, i.e. you offer larger packages for the same end consumer price for a limited time period. Your reports will show the effect as a price reduction or a decrease of product profitability.
" Using KPIs helps identify what works and what does not, what deserves our attention and what is less important, what are possible areas of concern and where we should set our priorities "
This is a joint responsibility within a company (in other words, nobody is really responsible). What you are actually doing is implementing a marketing action (you offer the end consumer a better price to increase your volume sold), therefore you may want to consider these costs as marketing expenses. This way, you can evaluate the success of the activity, and clearly identify who can influence performance.
Step 2: Choose the right basis for performance.
KPIs can only be a ratio of one measure to another. Analysts will often choose some size measure and report for example P&L figures as a ratio to turnover. So you will hear something like ‘travel expenses’ are 3% of turnover – a pretty innocuous value. Now imagine evaluating your travel expenses not as a proportion of your turnover but as a proportion of what is left after deducting all non-discretionary costs you need to be able to bring your product or service to life (cost of goods sold): in this case, you would deduct raw materials, packaging, logistics, direct manufacturing costs and so on. Say you are left with 40% of your turnover. Now, your travel costs, which you quantified as 3% of turnover is suddenly 7.5% of what you have available after having manufactured your product. It does not stop here, though: You want to market your product, otherwise nobody would know it or buy it, you want to pay salaries for your indirect employees (or pay outsourced services) and possibly depreciation of the machines you utilise. Say all these costs together account for another 20% of sales. Deduct it from your 40%, now you are left with 20% of ‘free turnover’: now you see that with 3% of turnover you are actually spending on travel expenses 15% of what you have left after deducting some necessary costs from your turnover. It is the same as valuing your expenses as a ratio of your gross salary or your disposable income.
Which basis exactly you want to use will depend on the type of business or company you are in. Certainly, identifying which cost items are discretionary and which ones are not will help create awareness in the organisation and again set your priorities appropriately.
Step 3: measure your prices accurately.
Your selling price is the biggest lever for your profit. Therefore it is important that you measure it correctly and assign responsibility in a clear, unequivocal way.
Companies report some form of gross profit by deducting the cost of goods sold from turnover. The ratio is a commonly used indicator that allows quick and easy comparison across companies and time periods, but all it says is what is left of your turnover after the costs of your goods as a proportion of your sales. Do you have a price issue? Have your costs of goods gone up? Who is responsible for it? The ratio alone will not answer any of these questions. Try another one: Divide your turnover by the cost of goods sold. They are the same two numbers, but instead of subtracting one from the other, you divide one by the other. The result will tell you how much you are charging your customer for every unit of currency the product costs. This is a typical marketing responsibility.
At the end of the day, nothing will substitute your experience, analysis, and understanding of your own company in steering its profitability, but in such a fast-changing world it is more and more important that you focus on those aspects that really drive performance. A good set of KPIs is a good start to set your priorities right.
