Choose KPIs That Measure the Drivers Success, Not the Results

Lagging indicators measure outputs or results. They are easy to measure, but hard to improve or influence.

Example: I’d like to lose 20 pounds. Step on the scale and the lagging indicator (weight) is easily measured. Still, it is hard to influence. Weighing myself every day doesn’t cause me to lose weight.

Leading indicators measure inputs or activities. They can be hard to measure, but easy to influence.

Example: To achieve my weight-loss goal, I need to eat less and move around more. Calories consumed can be hard to measure, but easy to influence (eat smart, smaller portions of low caloric density foods). Calories burned can also be hard to measure, though easily influenced by increasing physical activity. The hardest part is putting on my shoes!

“Ok, I get the concept, “ you say. “You’ve convinced me to drop the donut and up my step count, but how does this apply to business?” Start by measuring and discussing activities in your business instead of results.

Take sales for example. Nothing happens until someone sells something. Unfortunately, you cannot manage sales. You can only manage the activities that drive sales. Look to the selling processes to determine what you must get right to successfully drive sales in your business. Then measure it.

Perhaps your selling cycle begins with an investment in marketing. Marketing drives leads, like web inquiries or phone calls. A percentage of those leads become customers who buy something.

The ultimate result we’re after is sales. That’s the lagging indicator. To lift sales, focus your team’s attention on the leading indicators. That is, the indicators that measure the activities that drive sales: marketing cost per lead, lead conversion percentage, new customers and average ticket. Set goals for each and monitor activities frequently – at least monthly, or even weekly. Recognize and celebrate accomplishments. Reward your team commensurate with their performance. Sounds simple, right?

Talking about KPI's Click To Tweet

Think of KPIs as a Team Sport

Choose your KPIs wisely because they DO drive behavior. Let’s say you reward your marketing department based on lowering the cost per lead. They will want to produce as many leads as possible for as little money as possible. If they are successful, they will produce a lot of leads, and many will be of low quality.

If your salespeople’s performance is measured by the percentage of leads they convert, they aren’t happy because more than half of their leads were low-quality web leads. People surfing the internet clicked through because they were curious about something but were never good prospects. Sorting through all the bad leads causes response times to suffer for the people who WERE good prospects. Your incentive plan for the marketing department continues to drive the problem, and your salespeople are frustrated because they can’t accomplish their goals.

You might reward the marketing department based on qualified leads – but that will be hard to define. What if you rewarded them based on customer acquisition cost? That is, marketing costs divided by the number of new customers. Now they only get rewarded if the marketing AND the sales processes are efficient together. And a more efficient business is a more profitable business.

Use Gross Margin as a Leading Indicator, Not Just a Lagging Indicator

Gross profit margin measures how efficiently we produce our products or services in relation to the price we charge. If we don’t get that right, it won’t matter how much we sell. Gross profit margin (gross profit divided by sales) is a lagging indicator to labor efficiency, materials cost control, pricing and discounting practices. But it is a leading indicator to net profit.

Every bit of improvement you make to gross profit falls right through to the bottom line. That’s why restaurant operations will be so focused on food costs and controlling waste. Printers are concerned with jobs that need to be rerun because they do them twice and only get paid once. Repair services avoid callbacks. Find the definition of waste in your products or services and measure it. Now you’ve got some KPIs that are leading indicators to a strong gross profit margin.

Look Beyond the Financial Statements for your KPIs

Financial statements represent lagging indicators. Look beyond the accounting system where activities that drive a successful business are tracked. CRM tools, point of sale systems, job costing and scheduling or dispatch systems are great sources of leading indicators that are “just the right KPIs”.

What else must you absolutely get right to be successful in a business like yours? The answer will determine the areas that deserve your focus. For most businesses, sales, labor productivity and marketing should be in the mix.

Labor KPIs might include revenue per labor hour or labor dollar. Professional services firms watch time records to monitor the percentage of hours worked that are charged to clients. If staff shortages cause costly overtime, measure overtime pay as a percentage of total payroll. If you are understaffed, measure the number of qualified job applicants interviewed.

Other non- financial statement leading indicators vary by industry. Here are some you might adopt as KPIs:

• • Reruns/Do Overs
  • Safety Incidents
  • Equipment Utilization
  • Customer Retention
  • Proposals Under Review
  • Permit Applications Submitted
  • Staff Turnover
  • Candidate Interviews or New Hires
  • Leads, Conversions, Average Ticket by Lead Source
  • Referrals per Referral Source
  • Inventory or Accounts Receivable Turnover
  • Customer Satisfaction or Likelihood to Refer

Why are These KPIs so Different from What the Banker Reviews?

Bankers focus on lagging indicators, and in their defense, it’s all they can do with the financial statements they receive. Those reports and the ratios you can calculate from them represent results – the lagging indicators. Their experience has shown that poor results lead to financial failures. Their job is to assess whether the business is a good credit risk, not to improve the operations.

While your management team’s success is measured by lagging indicators, it is driven by leading indicators. To improve results, focus on the activities that drive improvement – the leading indicators. They probably won’t come from the financial statements.

So, decide on what you absolutely must get right and choose “just the right KPIs”. Set goals for each. Then make reviewing them a team sport, get focused, and get going!

Listen to Barb’s podcast on this same topic, Key Performance Indicator’s (KPIs). It’s part of Profit Soup’s Small Business Podcast Series from Profit Soup and the University of Louisville YUM! Center for Global Franchise Excellence.