In this paper we describe the importance of identifying a small set (10 to 20) of Key Performance Indicators (KPIs) to reflect the current status and direction of an organization. Without the identification of this compact set of KPIs, managers are likely to be overwhelmed by the large number of performance measures that are routinely generated by an organization’s computer system. The identified KPIs are frequently organized into cohesive groups. One such structure is called the Balanced Scorecard which organizes KPIs into four groups: financial, customer, internal processes, and learning and growth (employees). The identification of KPIs and Balanced Scorecard groups is best motivated by a carefully-constructed Mission Statement. It is the KPIs that can motivate employees, on a daily basis, to act in ways that are consistent with the strategic Mission Statement.
People usually mistakenly think that accounting involves only measurements of assets, such as cash or land, and measurement of expenses, such as rent or electricity. Those are certainly important measurements, but organizations use many additional numbers as they monitor performance on a daily basis. For example, a retail store chain carefully tracks its sales per square foot; a higher number means that the company is using its building more efficiently to generate sales. A high-tech company might track its overall research and development spending as well as the amount it spends on R&D per employee. A trucking company probably measures the percentage of its orders that are delivered on time. And it makes sense for all businesses to measure and monitor customer and employee satisfaction.
An organization is a complex entity. A manager can’t run an organization just by looking at one number. For example, return on equity is a great financial ratio, but a company CEO needs to know more than just the company’s ROE to run the business. What about employee satisfaction? What about percent of production capacity utilized? As another example, percent of deliveries made on time is a great measure for a package delivery company, but that is not the ONLY thing to measure. How about fuel efficiency? How about speed of collecting cash from customers?
The reporting challenge in an organization is to identify the key measures, to organize those measures into a framework that makes them easy to remember and understand, and then to design a performance evaluation system that will give people in the organization an incentive to pay attention to these measures. In this paper, we discuss these kinds of Key Performance Indicators or KPIs. We also discuss the Balanced Scorecard as one way for a company to organize its KPIs.
Key Performance Indicators
In the 1870s, Albert Fink was an executive for the Louisville and Nashville Railroad. The Financial Panic of 1873 in the United States placed financial stress on the railroad and caused Mr. Fink to look closely at railroad costs. He focused on just a few key measures, the most prominent being the cost per ton-mile … the cost of shipping one ton of freight one mile. Mr. Fink found that this cost varied dramatically, from as low as one-seventh of a cent for high volume freight carried against the normal flow of traffic, in cars that otherwise would be returning empty, to 73 cents for freight carried in small quantities in the busiest sections of the railroad. In other words, it cost 500 times as much to ship some freight. 500 times! So, Mr. Fink focused on this one number, this Key Performance Indicator, or KPI, as he successfully organized operations in the Louisville and Nashville Railroad.
These days, this relaxing notion of running an organization by focusing on one single measure has been overwhelmed by the quantity of data that we have available. In the past 50 years, the cost of data gathering, analysis, and communication has plummeted dramatically. For example, 1972 information storage disks holding just five megabytes were about a meter in diameter, one centimeter thick, and cost US$5,000. At the time, a person could buy a new car in the United States for US$2,000. So, in 1972, it cost the equivalent of the price of two-and-a-half new cars to buy five megabytes of storage capacity. How much would it cost today to buy a storage device holding five megabytes? You can’t do it. It is too small. In essence, five megabytes of storage capacity today is free. Similar advances have made in computing power and in data transmission speed.
So today, if Mr. Fink were trying to run the Louisville and Nashville Railroad, he wouldn’t need to restrict his attention to just one measure, the cost per ton mile. The railroad’s computer system could generate hundreds or THOUSANDS of detailed measures. But what hasn’t changed is the capacity of the human brain to store and process information. Our limited brains can be SWAMPED and overwhelmed with the vast amounts of data generated by even a simple business information system. This increase in computing power and the quantity of available data, combined with the unchanged cognitive capacity of the human brain, has made it increasingly important for organizations to boil down all of these data into a few important measures, a few Key Performance Indicators.
Can an organization have too many Key Performance Indicators, or KPIs? Of course it can. The word “Key” means that the organization has gone through a selection process to identify a few measurements, out of many possible ones, that are most important. So, how many is too many? In 1956, George Miller, a professor of psychology at Princeton University, published a paper titled: “The Magical Number Seven, Plus or Minus Two: Some Limits on Our Capacity for Processing Information.” The title itself is an embodiment of the idea of summarizing a complex set of data into a few key measures — Professor Miller’s research indicated that the human brain can store 7 items of information in working memory …a couple more for numerical digits and a couple less for complete words. So, as we consider the question of whether an organization can have too many KPIs, let’s keep this number “7” in mind.
Next, let’s talk about the Pareto Principle. This principle is named after the Italian economist Vilfredo Pareto who found that 80% of the land in Italy was owned by 20% of the people. This 80/20 rule of thumb has been found to work in many different situations. For example:
- 80% of the profit of a company comes from just 20% of the products.
- 80% of the student-related problems at a university are caused by just 20% of the students.
- 80% of the users of a piece of software use just 20% of the software features.
With respect to KPIs, the Pareto Principle suggests focusing on a few key measures, the measures that reflect the essence of the most important organizational drivers, the 20% of factors that drive the 80% of the results.
So, how many KPIs should an organization have? The consensus seems to be that the number of KPIs should be somewhere between 10 and 20. Yes, this is more than Professor Miller’s 7, plus or minus 2, but here we are taking advantage of the fact that we can write these numbers down, or put them on a computer screen, so that they don’t have to be stored in the short-term memory of our brain.
With too few KPIs, you are missing measurements that can tell you something important about your complex organization. But with too many KPIs, you are overwhelming the human brain. And an overwhelmed brain tends to just start blocking things out, randomly. It is better to strategically go through a set of potential KPIs and identify the most important ones rather than have a manager’s overwhelmed brain randomly focus on a few items. So, what is the best number of KPIs? Somewhere between 10 and 20.
Numerical measurements can be powerful motivators of behavior. Part of the strategic planning of any organization should involve identifying a relatively small set of important measurements, Key Performance Indicator (KPIs), that reflect the essential dimensions of that organization’s performance and status. Unless this identification of KPIs is done carefully, the danger is that the set of “key” measurements will balloon to dozens. The human brain can’t pay attention to dozens of “key” measurements, so most of the items on this bloated list will be ignored.
An Introduction to the Balanced Scorecard
The Balanced Scorecard is a framework for organizing a company’s performance measurements, or Key Performance Indicators (KPIs). One way to structure the Balanced Scorecard is to organize the KPIs into four areas: Financial, Customers, Internal processes, and Learning/growth (employees). Realize that the IDEA of the Balanced Scorecard is what is important here. These four categories are not official; this is just one way to structure an organization’s KPIs. The Balanced Scorecard IDEA is that a company should organize its KPIs into logical categories.
Financial measures are the ones on which accounting has traditionally been focused: return on equity, bottom-line net income, debt ratio, and so forth. One benefit of a Balanced Scorecard is to remind everyone in an organization that Financial measures are not the only measures that should be tracked, talked about, and used in performance evaluation.
The Customer category of the Balanced Scorecard includes measures, or NUMBERS, that reflect the health of a company’s relationship with its customers. Here we are not talking about general THINKING about the customers. Instead, we are talking about specific NUMBERS that measure customer relationships, such as customer satisfaction ratings. Now, customer satisfaction ratings have not traditionally been considered to be part of accounting. But the power of the Balanced Scorecard is to remind a company that in addition to reflecting a company’s financial performance, numbers can also nicely reflect the health of other aspects of the business.
The Internal Processes measures are summary numbers reflecting how well the actual business is functioning. An Internal Processes measure for an eyeglasses store, for example, would be the daily number of eyeglasses returned to the technicians because the glasses are broken, don’t fit the prescription, or are not what the customer ordered.
The Learning and Growth measures might be better labeled Employee measures. An example is a measure of employee satisfaction, a number reflecting how satisfied employees are with the work environment, their pay, their co-workers, their bosses, and so forth. In most businesses, if the employees are satisfied and enthusiastic, everything works better.
An important impact of the Balanced Scorecard idea is that ACCOUNTANTS are now thinking about and measuring non-traditional numbers such employee satisfaction, customer service, and process monitoring. Of course, in the end, all of this focus on customer measures and internal processes measures and employee measures aids the company in improving its financial performance.
Below is further discussion of each of the four basic Balanced Scorecard categories.
Traditional accounting measures have only included financial measures. And, in a strict, profit-maximizing sense, financial measures are all that matter. In that sense, you can view the other three dimensions of the Balanced Scorecard as being dimensions that ultimately feed into improving long-term profitability.
The key point is this: As part of its strategic planning process, a company needs to determine exactly what its financial goals are (maximize short-term profits, increase long-run survivability, or perhaps something else) and then design measures that will help in monitoring progress toward these financial goals.
The first key to strong financial performance is identifying customer needs and satisfying those needs. When companies understand what their customers want and will pay for, then these companies can design customer-focused performance measures that lead to growth in market share, increased revenues, and long-term profits.
With customers, let’s think of Leading measures and Outcome measures. Leading measures reflect whether the company is currently meeting or exceeding its customers’ expectations. Outcome measures reflect whether customers are staying with the company and whether those customers recommend the company to others.
Here are examples of Leading Measures.
- Number of returned items. An increase in the number of customers who are returning items is likely to lead to a decrease in returning customers.
- Percent of on-time deliveries. If you are delivering a product or service and you promise delivery at a certain time, your customers are going to respond negatively to late delivery. A decrease in the percentage of on-time deliveries is not a good omen for future customer retention.
These Leading measures give us advance warning of possible future problems in terms of retaining customers and attracting new customers.
Here are some examples of Outcome Measures.
- Number of returning customers. The number of returning customers can be quantified in various ways such as the fraction of customers last quarter or last year who have returned this quarter or this year. The best customers are returning customers because you don’t have to spend money to find them and to get them to try your product or service. Of course, there is a connection between having an enthusiastic base of existing satisfied customers and the ability to attract new customers.
- Number of new customers. The number of new customers can be measured in terms of actual number of new customers or dollars of new-customer business. Also, it is important to track the cost of attracting new customers, if for no other reason than to remind you how costly it is to replace any customers you lose because of not meeting the expectations of current customers.
The Customer measures in the Balanced Scorecard remind managers that strong financial performance starts with satisfied customers. The existence of both Leading and Outcome measures reminds managers that it is better to measure, detect, and fix problems with customer relations rather than to measure a drop in the number of customers and then sit around and try to figure out how to get them back.
The Internal Processes measures in the Balanced Scorecard framework help managers monitor how the business is actually working. These Internal Processes measures can be organized into three groups: Innovation measures, Operations measures, and Service-after-Sale measures.
- Innovation Process Measures reflect the process of identifying and creating new products. For many companies, innovation is where much of a company’s competitive edge is created. It is important to the ultimate financial success of the organization that the critical effort to identify and develop new products and services is effectively managed. For example, for companies operating in rapidly evolving markets, a discipline of spending money on research and development is crucial. So, one Innovation Process measure might be the percentage of revenue spent on R&D. Without this perspective, the accountants and the budget cutters would slash R&D spending at the first sign of a temporary decline in profits. And by so doing, they might ensure that the decline in profits becomes permanent.
- Operations Process Measures reflect the activities directly related to the sale of goods or services to customers, including receipt of customer orders, creation of products, and delivery of products. In the area of operations management, this is sometimes called Six Sigma. Six Sigma is the idea that operations processes should be so designed and monitored as to reduce the number of errors or defects to just a handful (3 or 4) in a million.
- Service-after-Sale Process Measures are of two types. One type of service-after-sale process involves the billing and collection of payments from customers. The other type involves the organization’s commitment to back its product, including efforts to repair or replace products and provide post-sale support and guidance in the use of the product. Billing and collection don’t sound very exciting, but companies that aren’t able to efficiently collect cash from customers, without alienating those customers, aren’t going to survive long. So, a good measure is really that old financial measure, average collection period, which is the number of days from the time of sale until cash collection. The success of continuing customer support can be measured by the time elapsed between the receipt of a customer request and the satisfaction of that request.
The Service-after-Sale Process Measures illustrate the inter-relation of the Balanced Scorecard measures. Depending on a customer’s experience with service after the sale, that customer is more or less likely to be satisfied. Recall that customer satisfaction is a Leading measure in the Customer section of the Balanced Scorecard. Higher customer satisfaction means better customer retention, a Customer Outcome measure. And better customer retention means better Financial returns. None of this happens if the business operations are not functioning properly. The Internal Processes measures in the Balanced Scorecard framework help managers monitor how the business is actually working.
Learning and Growth Measures – The Employees
The Learning and Growth measures focus on the company’s employees. Traditional financial measures can cause managers to view employees as a COST. The Balanced Scorecard forces a manager to view employees as a key RESOURCE. An infamous example of this is the statement by Jerry Krause, general manager of the National Basketball Association (NBA) Chicago Bulls during the 1980s and 1990s. He said that players don’t win championships, organizations win championships. Well, it turns out that organizations with the right players (such as Michael Jordan) win championships. With Michael Jordan, the Bulls won 6 NBA championships. Without him, they haven’t won any.
Many companies these days are constantly talking about “work-life balance” of their employees Is it because these companies are charitable organizations that care only about their employees’ happiness? No. Instead, these companies realize that their good employees are a RESOURCE, not a COST, and companies can increase their financial profits by retaining their good employees.
Here are some examples of Employee-related measures.
- Employee training. As with spending on research and development, this measurement of spending on employee training reflects a key change in perspective: spending money on training is not a negative, it is a positive. Measuring spending on employee training, or tracking the number of employees who have completed additional certification courses, reminds managers that money must consistently be spent on employee development in order to keep the employees satisfied and engaged. Again, without this perspective, the accountants and the budget cutters would slash compensation and increase layoffs at the first sign of a temporary decline in profits. Such short-term actions, motivated by a focus on just measures of short-term profits, reduce employee loyalty and increase the cost of doing business in the long run.
- Employee productivity. The ultimate result of building learning and growth in the organization is to enhance employee productivity. Companies often measure and report their sales per employee. A software development company might measure the lines of computer code generated per employee. A telemarketing company measures the number of sales calls made by an employee. Many of the statistics generated in connection with professional sports teams are really just measures of different dimensions of employee/player productivity.
- Employee satisfaction. Companies often think about conducting surveys to measure customer satisfaction. Similarly, it makes sense to survey employees to measure their level of satisfaction. You can think of poor employee satisfaction as being a leading indicator for subsequent costly employee turnover.
These three issues – employee training, productivity, and satisfaction — form the desired outcome measures of learning and growth. Therefore, the organization should track performance in the productivity, retention rates, and satisfaction of its employees. A good accounting system can (and should) measure satisfaction of employees using surveys; reporting on resignation trends within the company; and measuring employees’ productivity in terms of volume, quality, and timeliness of output.
To review, the Balanced Scorecard is a framework for organizing a company’s performance measurements, or Key Performance Indicators (KPIs). A traditional way to structure the Balanced Scorecard is to organize the KPIs into four areas: Financial, Customers, Internal processes, and Learning/growth (employees). The Balanced Scorecard framework is an aid to help managers identify areas in which they should create Key Performance Indicators.
The idea of the Balanced Scorecard is that this set of KPIs can usually be organized into cohesive categories. The four categories used in the Balanced Scorecard are financial, customer, internal processes, and learning and growth (employees). These four categories are just examples; an organization should use the IDEA of the Balanced Scorecard to inspire its identification of the Balanced Scorecard categories that best match that organization’s objectives.
Mission Statements and Key Performance Indicators (KPIs)
An important aspect of running a company is a general agreement among the ownership team and the top managers about the company’s strategic direction. This strategic direction, or mission statement, is important in establishing both those things that the company will do and those things that the company won’t do. For example, history is riddled with companies and other organizations that have experienced difficulties as their efforts have become unfocused. They are like a little child, splashing around in a pond trying to catch ALL of the fish and ending up catching none of them.
We have all seen lots of mission statements over the years. There is a tendency for mission statements to be vague. One criterion for evaluating a mission statement is as follows: Does the statement make clear what the organization will NOT do? It is very easy, when making a mission statement, to promise the sun, the moon, and the stars. “We will do everything!” But a mission statement that promises everything really doesn’t give an organization any guidance in how to direct its scarce resources and the scarce time of its people.
Here is an example of a mission statement from a well-known company that is almost certainly too vague to be of any use: “Our mission is to empower every person and every organization on the planet to achieve more.” Can you guess which company this is? You certainly don’t get any hints from the statement itself. This is the mission statement of Microsoft. With all due respect to Microsoft, that statement really isn’t of much use because it doesn’t make clear what things Microsoft will and won’t do. Under that mission statement, can they sell software? Sure. Hardware? Yes. Groceries? French fries? Construction equipment? Banking services? Yes. In short, this Microsoft mission statement provides no strategic direction. This mission statement really doesn’t help Microsoft at all in terms of deciding how to spend its scarce resources and how to direct the efforts of its employees.
Now, here is the mission statement of McDonald’s: “Our mission is to be our customers’ favorite place and way to eat and drink.” This is a great mission statement. This McDonald’s mission statement suggests that McDonalds has decided, at least for now, not to extend its powerful brand name into a broad array of goods and services. McDonald’s has a worldwide reputation for consistency and value. So, would people buy McDonald’s gasoline? Probably. Would people stay in a McDonald’s hotel? Yes. Would people deposit their money in a McDonald’s bank? Possibly. But the mission statement says that, for now, McDonald’s is focused on a certain place and way to eat. The mission statement provides direction.
An example of a very precise mission statement is the acquisition criteria of Berkshire Hathaway. These criteria are reprinted each year in Warren Buffett’s letter to the Berkshire Hathaway shareholders. As an example of the specific nature of this statement, one of the criteria is that all potential acquisitions be large, with the target company already generating annual before-tax earnings of at least $75 million. A couple of more items on the list are as follows.
- We will not engage in unfriendly takeovers.
- [We are interested in] simple businesses (if there’s lots of technology, we won’t understand it).
These acquisition criteria make clear what Berkshire Hathaway will, and will not, consider in terms of buying companies.
A mission statement can also involve a much broader vision. For example, the mission statement of Ben & Jerry’s (which is now owned by Unilever, a Dutch-based consumer products company that is also the largest seller of ice cream in the world) includes three dimensions.
- Product Mission: To make, distribute & sell the finest quality all natural ice cream … and promoting business practices that respect the Earth and the Environment.
- Economic Mission: To operate the Company on a sustainable financial basis of profitable growth, increasing value for our stakeholders & expanding opportunities for development and career growth for our employees.
- Social Mission: To operate the company in a way that actively recognizes the central role that business plays in society…
Some potential shareholders might disagree with Ben & Jerry’s emphasis on the environment, nurturing labor practices, and social awareness. Fine. The beauty of a good mission statement is that it tells potential investors what fundamental principles will be used by management in making corporate decisions. If an investor disagrees with these fundamental principles, then she or he can easily decide to invest in a different company.
In summary, a good mission statement is specific and clear enough to identify what types of activities a company will focus on as well as what things a company will not do.
Now, we should make clear how mission statements relate to accounting, Balanced Scorecards, and Key Performance Indicators, or KPIs. The Key Performance Indicators as organized in the Balanced Scorecard are what bring the Mission Statement to life.
To aid in this discussion, we will use a hypothetical example of an optometrist’s office. For those of you with perfect eyes and so have never visited an optometrist’s office, an optometrist is a person who diagnoses, prescribes, sells, and fits eyeglasses and contact lenses. So, imagine that you are an optometrist with your own practice. Your current strategic position is as follows. For the past 20 years, you have focused almost exclusively on the profitability of your practice as your sole performance measure. In fact, you have been quite profitable. However, during the past two years, a number of new, low-cost, commercial optometrist offices, including outlets based in supermarkets, have opened in your practice area. In addition, some of your customers have discovered that the absolute lowest cost way to buy eyeglasses and contact lenses is through online sites. As a result, your profitability has decreased to the point where you are barely breaking even. This profitability problem has caused you to dismiss some of your part-time employees; the remaining staff are feeling their jobs threatened and are not as patient and helpful with customers as they used to be. Your long-time customers are also not as satisfied as they were in the past; they feel rushed (because you are trying to see more customers to increase profits), and they feel that the office staff are placing more emphasis on financial matters such as quick payment. You have also noticed a substantial decrease in new customers.
Because of your concern for your practice, you have asked a business consultant what you should do. She has told you that your single-minded focus on cost reduction is no different than that of your new commercial competitors; she has convinced you that these competitors will be more successful than you in competing for customers based on price because they have lower cost structures than you do. She has suggested that you consider formulating a Mission Statement for your practice and then creating some Key Performance Indicators within a Balanced Scorecard framework. Accordingly, you have formulated the following Mission Statement:
Provide lifetime, high quality eyecare to individuals and families, with an emphasis on courteous, flexible service and respectful disclosure and consultation in terms of options and costs.
Let’s take a moment and determine whether this is a good mission statement. This is a good, focused mission statement because it tells us what the optometrist is and is not going to do. Notice the emphasis on quality, service, and lifetime relationships. This mission statement makes clear that the optometrist is not going to try to compete with the low-cost providers, the supermarkets and the online sellers. Instead, the optometrist is going to focus on service and developing long-term relationships with customers. This mission statement defines what actions the optometrist views as being important. It is then the job of the accounting system to measure, and reward, those actions.
To continue with the optometrist example, assume that the optometrist has decided to focus on a set of KPIs based on a Balanced Scorecard. Those KPIs include the following two measures:
- Percentage of customers who must wait more than 15 minutes after appointment time before seeing the optometrist.
- Average gross revenue per customer visit (including both the fee for the visit and the billing price for the eyeglasses or contacts ordered).
Let’s first consider the KPI of the percentage of customers who must wait more than 15 minutes after appointment time before seeing the optometrist. To keep this example simple, let’s not worry about how the optometrist will measure these waiting times; let’s assume that the optometrist has found a perfect measurement device that the receptionist can’t manipulate. Perhaps it is as simple as patients being required to sign in and out on a written log.
Also, to make things more specific, let’s assume that the office receptionist has been made responsible this KPI. Each Friday morning, at the weekly staff meeting, the office receptionist will be required to explain the trend, positive or negative, in this waiting-time measure.
Let’s consider how the receptionist’s behavior might change once this measure begins to be discussed at the weekly staff meetings. With this measurement and evaluation system in place, instead of passively sitting behind his desk the receptionist is going to constantly monitor the people in the waiting room. How long has each person been there? What time is their appointment? The receptionist now has a personal interest in each patient, and in his or her time. We see how employees behave differently just because a certain activity is now being measured.
The receptionist would be very careful about scheduling, checking the details of each appointment to make allowances for consultations that might take extra time. If the receptionist can see that the optometrist and her staff are running late, the receptionist may decide to call scheduled patients and offer to reschedule. Can you imagine how you would feel if you got a call from your optometrist or doctor or dentist that went as follows: “The doctor is running late. Your time is important to us. Rather than come to the office and just sit in the waiting room for an extra 30 minutes, would you like to reschedule your appointment time?”
Now, this is not a perfect measure. The receptionist may now have an incentive to spread the appointments too much, cutting down on the number of patients, and so hurting revenue. The optometrist will need to keep an eye on this. But the key point is this: The receptionist will now do his job differently. Not because he is loyal to the optometrist. Not because he is loyal to the patients. Not because he has attended a series of seminars on customer service. No, the receptionist will pro-actively think of ways to serve the patients better because of the simple fact that a new accounting measure, a KPI, is now being tracked and then discussed in the weekly staff meeting.
In addition to measuring the percentage of customers who must wait longer than 15 minutes, the optometrist has now instructed her accountants to track the following for each staff person who does patient consultations: Average gross revenue per customer visit (including both the fee for the visit and the billing price for the eyeglasses or contacts ordered). Let’s say that there are 10 optometrists and assistants who will be evaluated based on this measure. In fact, to take this example to the extreme, let’s assume that a list, a ranking, is to be distributed at the Friday staff meeting each week showing the list of 10 names and their average revenue per customer visit. This has now turned into an intra-office contest, with potential implications for who gets a promotion, who gets a raise, and even who gets fired.
Let’s consider what problems might be caused by this measure. Remember that the new Mission Statement contains an emphasis on quality, service, and lifetime relationships. In fact, the Mission Statement contains this clause: “respectful disclosure and consultation in terms of options and costs.” Surely the optometrist will have nice copies of the mission statement professionally printed, framed, and hung in each of the examination rooms as well as out in the patient waiting room. But how can employees be expected to take this noble Mission Statement seriously when their performance evaluation is based on how much money they can squeeze out of every customer? Respectful disclosure? Consultation about costs? No. If my performance is going to be evaluated every week based on the average gross revenue I get from each patient, and if the optometrist is going to compile ranking lists showing which staff people are getting the most gross revenue per visit, and if my raises are going to be delayed because I am not upselling the customers to more expensive glasses and contact lenses, then I don’t care about the Mission Statement. I don’t care about service. I don’t care about “respectful disclosure.” I just care about revenue per patient visit.
You see, if there is a conflict between the noble Mission Statement and the KPI that is used to evaluate employees, then the employees will ignore the Mission Statement and only pay attention to the KPI. If you don’t believe in the Mission Statement, throw it away. If you do believe in it, don’t measure employees in a way that causes them to ignore the Mission Statement. The accounting numbers, these “Key Performance Indicators,” are what put the meat on the bones of the Mission Statement.
A Case Study in Key Performance Indicators (KPIs): XYZ Trucking Company
This case study illustrates the impact of Key Performance Indicators, or KPIs. This specific case is for a company in the trucking business, but the general principles can be applied to all industries. This little case is for a hypothetical company, XYZ Trucking, but it is adapted from some information and measures of a real trucking company. We thank our colleague, Professor Don Livingstone, for providing some of the information we have used in constructing this case.
XYZ Trucking is based in the United States. The company focuses on short to medium trips; the average length of its trips is 540 miles. XYZ Trucking targets service-sensitive customers; it is not focused on price competition. The company accepts only “full trailer loads,” so it drives to a customer location, the customer loads whatever it wants in the trailer, and then the XYZ driver takes that load to the designated location. There are no detours for picking up other loads and no splitting of a trip among several customers. Very simple. The shipping fee is negotiated for each job and is stated in terms of the fee per mile.
As with most service-focused businesses, the success of XYZ Trucking is based on the strength of its relationships with its customers, especially its large customers. XYZ’s largest 20 customers account for about half of total sales, so the company assigns an individual account manager for each of these large customers. The job of these account managers? Take care of any concerns the customers have.
Of course XYZ is always seeking to expand its business. Company sales people are constantly seeking to create and expand relationships with customers who have decided to stop operating their own in-house trucks and have instead decided to outsource their shipping to trucking companies such as XYZ.
XYZ’s biggest operating cost, by far, is the compensation cost for the drivers. Total compensation cost is about 50% of revenue. XYZ is constantly seeking, hiring, and training new drivers because of the large driver turnover that is typical in the trucking industry. For new drivers, XYZ operates its own three-week training school, followed by an additional two months of on-the-job training.
Drivers are paid on a per-mile basis; with the rate per mile increasing the longer the driver stays with XYZ. XYZ also pays bonuses to drivers who reach certain length-of-service thresholds. This bonus system gives the drivers an added incentive to stay with XYZ rather than switch to a competing trucking company
XYZ’s second largest operating cost is the cost of fuel. The fuel cost is the most volatile of XYZ’s operating costs, fluctuating up and down with the worldwide price of oil. XYZ attempts to reduce its fuel costs by operating its own fuel depots. XYZ can save 10% on its fuel costs if its drivers refuel at a company-owned fuel depot rather than at a commercial truck stop.
The CEO and senior staff of XYZ trucking meet every morning at 8:00 a.m. In this mini-case we will discuss which four numbers the CEO and her top staff will want to look at each morning at their 8:00 a.m. planning meeting. In other words, what are the daily Key Performance Indicators for a trucking business?
Remember, we are at the daily 8:00 a.m. meeting of the CEO and top executives of XYZ Trucking. We are going to look at 4 Key Performance Indicators, or KPIs. These are 4 numbers that are going to dramatically influence the way people behave and how they spend their time on a daily basis.
The first measure is Driver Turnover. Specifically, this is the number of drivers who left the company yesterday. Remember that driver compensation is by far the largest operating cost for XYZ Trucking. Driver turnover is a major concern for all trucking companies. For example, we have heard of one trucking company for which the annual GOAL is 72% driver turnover per year. We are told that for this company ACTUAL driver turnover is always above 100% per year and that this high driver turnover is normal for a trucking company. Consider what it means to have over 100% turnover in key employees each year. People in most businesses can’t CONCEIVE of how they would deal with this high level of turnover in their companies.
If you are in the United States, the next time you are on the freeway look at the back of the big trucks on the road. There is almost always a sign on the back of the trailers that advertises for drivers. The sign speaks of good compensation and then gives a phone number to call. Now, is that sign speaking to you, the driver of a small car on the road? No, they don’t want you. That sign is placed at the eye level of other drivers, drivers who are driving for other trucking companies. Trucking companies are in a constant struggle to renew their driver group because of the driver turnover of over 100% per year. Happy, experienced drivers result in lower training and accident costs and increased customer satisfaction.
If you were the CEO of XYZ Trucking, you would like to have one executive tell you every morning how the company is doing with driver retention. Every morning at 8:00 a.m., you would look at the number of drivers who left the company yesterday, and the driver retention executive would then need to explain the trend: Are we getting better? Are we getting worse? Why?
The key point is this: The CEO would not need to tell this driver retention executive how to do her job. This one number, the daily driver turnover number, would cause her to spend her time each day thinking about the drivers, worrying about the drivers, and coming up with plans to keep the drivers happy and attached to the company. This executive might even develop some LEADING measures such as surveys of driver satisfaction. This executive would be pro-active in developing a positive relationship with the drivers. From the standpoint of the drivers, would appear that this executive really cares about them. And maybe she does. But another reason that she appears to care about the drivers is because of that KPI, the number of drivers who quit yesterday, and her responsibility to explain that number every morning at 8:00 a.m.
Billable Miles per Tractor per Day
The second KPI is Billable Miles per Tractor per Day. This is the total number of revenue miles driven yesterday, divided by the total number of tractors in the company fleet. By the way, in the trucking business the “tractor” is the front part, where the driver sits, and the back part, where the load is, is called the “trailer.” Notice that we are counting only Billable Miles. Driving a truck empty to get back to an XYZ Trucking base doesn’t earn us any money. And also, we are counting ALL tractors, including those that are currently down for repairs.
Our goal for this number is 650 Billable Miles per Tractor per Day. This is a pretty aggressive goal. Have you ever driven 650 miles in a day? In order to reach this goal, XYZ Trucking must have its tractors in good repair and the jobs scheduled very precisely so that when one driver finishes a trip, the tractor is scheduled to head out on another trip.
If you were the CEO, you would like to have one executive tell you every morning how the company is doing with tractor maintenance, keeping all of the tractors on the road. This executive might even develop some LEADING measures such as age of the fleet, and so forth. You would also want the master scheduler to tell you about any idle tractors and explain why they aren’t out on billable jobs. You would also want your vice-president in charge of sales to explain to you why some tractors are idle because we haven’t got any customer work for them to do. You would inquire about the plan for the company sales people to find new contracts so that those idle tractors can get back on the road.
In other words, there are three people who are going to be focusing their thoughts every day on improving this number, Billable Miles per Tractor per Day: the maintenance executive, the master scheduler, and the vice-president of sales. You don’t have to tell them how to do their jobs. You just need to look at the number together with them every morning and then ask them to explain why the number is getting better or worse. In essence, the number does all of the work. The KPI is the motivator.
Days Pickup to Cash
The third trucking company KPI is Days Pickup to Cash. This number is the sum of the time it takes to complete the following three actions:
- Time from pickup to delivery
- Time from delivery to billing
- Time from billing to cash collection
The company goal is to have every trip billed and collected within 30 days from pickup.
Whose performance should be evaluated based on this measure? There are three very different sets of people involved in this important number: the Scheduler, the Billing Clerk, and the Accounts Receivable Clerk. First, there is the Scheduler who is responsible for getting the loads delivered quickly. The computerized scheduling programs used by trucking companies are quite sophisticated. And these programs make the trucking business increasingly competitive. Some customer companies are reducing their reliance on one trucking company and are instead putting every shipment up for bid in the open market. These shipment jobs are posted and bid on, almost like shares in the stock market. And in order to be successful in these competitive bids, a company has to know where its trucks are and which of its drivers is ready to drive.
Then there is the Billing Clerk who is responsible for sending out the bills immediately after the loads are delivered. The Billing Clerk job doesn’t sound very exciting, but in this case that job is crucial. If the Billing Clerk sits on the bills for a few days, that is a few more days that XYZ Trucking is going to be without its cash. If XYZ doesn’t quickly get its cash from its customers, then when XYZ has to pay its bills (such as driver compensation), it may have to borrow money to pay those bills, driving up company costs. And it is foolishly optimistic to expect our customers to pay us before we even send them a bill. And it probably isn’t a good idea to send the bill before the work is done and the load is delivered. So, this Billing Clerk job is an important one here and is reflected in this KPI, Days Pickup to Cash.
Finally, there is the Accounts Receivable Clerk who monitors the age of receivables and who gently prods any customers who are slow in paying. This Accounts Receivable Clerk also works with the account managers for the large customers. The job of those account managers is to keep good relations with the customers so that they can kindly but firmly deliver the “Pay!” message when a customer is slow in paying.
As you can see, it might make sense to have three sub-measures here, one for each of the people or departments involved. If you were the CEO, you might designate one of your executives to be responsible for all three of these processes. Again, you don’t have to tell these people how to do their jobs. They just need to know that you will look at this KPI every morning and will want an explanation for any slowdown in the Days Pickup to Cash.
Percent of Fuel Purchased from Company Docks
The fourth and last KPI in this example is the Percent of Fuel Purchased from Company Docks. Recall that XYZ’s second largest operating cost is the cost of fuel. The fuel cost is the most volatile of XYZ’s operating costs, fluctuating up and down with the worldwide price of oil. XYZ attempts to reduce its fuel costs by operating its own fuel depots. XYZ can save 10% on its fuel costs if its drivers refuel at a company-owned fuel depot rather than at a commercial truck stop. The goal here is 90%. Assume that the company is currently at 70%. Now you may ask why our goal isn’t 100%, given that we get a cost savings of 10% for all fuel obtained from our own fuel depots. Well, we can’t get 100% because we don’t have full coverage. There are some parts of our service area where we don’t yet have one of our fuel depots.
OK, then why are we at 70% rather than 90%? Why aren’t our drivers getting the fuel at our own depots when it is available? Maybe the drivers just don’t think it is important. Maybe the drivers have an incentive to buy fuel elsewhere. For example, major truck stop chains have frequent filler rewards (just like frequent flier programs for airlines) so that the drivers get personal benefits from filling up at their favorite truck stop rather than at a company depot. Remember, the company pays for the fuel, not the drivers. So the drivers don’t suffer if the fuel costs a little more. And the drivers get the personal frequent-filler benefits from filling up at the commercial truck stops.
Let’s say that you are the company executive made responsible for this KPI, Percent of Fuel Purchased from Company Docks. Now that you have been made responsible for the number, you start thinking of how to increase company dock fuel purchases from 70% to 90%. Again, you see the power of accounting and KPIs. The company executive responsible for fuel purchases is now spending her time each day figuring out ways to increase the percentage. She could try to increase the percentage by educating your drivers, explaining to the drivers how much the company saves if the drivers get the fuel from the company depots. That might work, but we wouldn’t be surprised if appealing to the drivers’ company loyalty didn’t have much effect.
Why not use this notion of KPIs and performance evaluation on the drivers? Perhaps you could propose splitting the savings with the drivers. If a standard fill-up saves the company $50 if it is done at a company depot, then tell the drivers that you will give them $10 or $20 of the savings. Now, consider the behavior of the drivers. Will you ever have to speak with them about this issue again? No. With the proper measurement in place, the numbers themselves will motivate the drivers to do what you want them to do. The drivers themselves will plan their refueling stops to coincide with the locations of the company fuel depots.
From this XYZ Trucking Company example, we see the power of numbers in motivating behavior. For example, because of the driver turnover KPI, the driver retention executive will spend her time each day thinking about ways to improve driver satisfaction. It will appear that she has a personal interest in the welfare of the drivers, but the truth is that her “caring” behavior is motivated by her responsibility for the driver turnover KPI. The same is true with the other KPIs in the example: manager behavior throughout the day is motivated by the knowledge that tomorrow morning at 8:00 a.m. the KPIs will be discussed and the responsible parties questioned.
Because of the power of the KPIs to motivate behavior, you can see that it is extremely important to pay attention to what you measure. Managers and employees will focus on those measures, so the measures should be chosen carefully to motivate exactly the behaviors that will improve company performance.
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