Why KPIs are More than Just Numbers — and Crucial for Organizational Performance
How to Create KPIs, Use Them and Align Your Organization with Them
Every company has financial targets. Almost every company has some form of key performance indicators (KPIs) to measure organizational performance. These typically include return on equity, working capital, debt to equity ratio, inventory turnover and gross / net profit margin.
Successful companies invest large amounts of time in annual and quarterly planning sessions to ensure their businesses hit these KPIs. Adding to the pressure of hitting KPIs is executive accountability and the need to deliver shareholder return. In order for KPIs to be both effective and meaningful to employees in an organization, they need to clearly understand how their work contributes to the financial impact of the company.
Reduce Operating Costs and Increase Margins with Clear KPI Alignment
Earlier in my career, I was hired to be the President of a powder-coating company that was facing financial challenges. I had to quickly figure out where my team’s efforts were going to have the most value. But before I started making changes to maximize our operational efficiency, I first needed to slow down before I could speed up.
We conducted a detailed financial analysis which showed 50% of our production costs alone were in a powder material that was used in the manufacturing process. In order to understand whether we could find any cost savings, we measured the thickness of the powder we were applying on our metal parts. The company’s target was to apply 3 millimeters of powder, on average. However, the plant employees didn’t seem to be interested in trying to maintain that number. You would think that they would, given that it was the largest variable cost and that the health of the organization ultimately rested on using no more powder than necessary to maintain profitability.
What I quickly realized was that none of them connected with ‘3 millimeters of powder’. It was an amount that was barely perceivable so they couldn’t relate to its broader impact on the business. I calculated that if we exceeded the 3 millimeters of powder by just 1 millimeter for an entire year, it would cost the company an additional $300,000!
Improve Organizational Effectiveness by Using the ‘Power of 1%’
To ensure our entire manufacturing team understood our business problems and to help with change management, I brought everyone into our lunchroom and I wrote “1 millimeter” on the whiteboard. I proceeded to do the math showing everyone how one extra millimeter of powder led to $300,000. I broke it down by day, week, month and year so they could see how it all added up to a major cost for the company. I also used the WIIFM (What’s In It For Me?) approach to explain that this significant cost saving could allow greater employee benefits such as the flexibility to consider wage increases, year end bonuses or better health benefit plans.
This is an example of the Power of 1% concept. When using the Power of 1%, you’re continually asking “What would happen if we were 1% better (or 1 unit of measurement better)?” It could be either 1% more productivity, 1% less material in purchasing, collecting receivables 1 day earlier, or getting 1 more sales meeting per day. The first step is mapping out all of those potential enhancements. The next step is separating out improvements that the company can actually manage and measure effectively. You’ll quickly see some don’t have as big an impact as others.
Following that you would look at the financial impact. For example, if your receivables are at 30 days, you’re probably not going to reduce it to 25 days realistically since there’s not a big opportunity for improvement there. However, if your productivity rate is 1% better and you believed there was a potential upswing of 10%, then the impact is more significant. If you follow this approach, you’ll then be able to focus on the 8 to 10 KPIs that will truly improve organizational performance.
Create Results and Organizational Alignment by Communicating KPIs
After this town hall meeting, all our manufacturing employees were much more engaged with controlling the amount of powder we were applying. It even became a running joke where we reminded each other every day that “it’s not just 1 millimeter — it’s $300,000!”
What wasn’t funny, was how well we created organizational alignment.
You need to translate your KPIs financial impact to your company if you want your employees to be engaged in helping to improve organizational performance. If you don’t, they’re just numbers.
Are you interested in learning more about KPIs?
You can watch Andrew Rush’s latest presentation with TEC Canada on How To Create World Class KPI’s and Dashboards below.