How To Design Your KPI
Modeling True Indicators Of Your Business’ Performance
Key Performance Indicators have been popular for several decades. Despite their popularity, they are still poorly understood and engineered. To a large degree, using the term KPI has become a crutch. Throw a few metrics on a spreadsheet, title it KPI, and suddenly every one feels better.
KPI are intended to create understanding, that is why they are “key”. They are intended to measure accomplishment, but also shape — the “form” in performance is “key”. And finally, they are “indicators”— they are meant to “point”, not to simply record. With this in mind, perhaps you can already see how metrics like monthly revenue are poor KPI?
When I teach the basics of analytics, I often spend a full class on how to ask a good analytic question. You can read more here. How is critical to the process of creating great KPI. How is what provides the “form”. How turns mere numbers into a powerful model. You need to consider how.
Returning to monthly revenue — it is an outcome, a result, an accomplishment for sure — but not an “indicator” of how. You need to ask how you created that monthly revenue? Likely that involves a customer acquisition, a product shipped, or a series of transactions completed. These events are how your business grows. It is the changes in their trends that “point” to where your business is headed.
Coming back to how. Consider some simple questions.
- How many?
- How often?
- How much?
- How long?
- How far?
It might seem like semantics, but how questions provide a different perspective than typical who, what, when, and where ones. (Note — trying to answer why is a fool’s game.) How questions are best answered with models, not just numbers. While all numbers are technically symbolic models, great KPI take this to a higher level.
It is difficult to write specifically about measures and concepts that really are very custom to a business. Generalities are really more appropriate. But in attempt to provide higher value, let me end with an example.
Assume you have a lemonade stand. You are interested in developing KPI to indicate the health and well-being of your stand. You could record your monthly revenues and costs, many companies would. But if the revenue starts to fall or the cost begin to rise — what do you do?
You need to understand how that revenue is generated (cost as well). You need to understand the story of your business and model this in your KPI.
A lemonade stand’s revenue is predicated on the number of customers it serves. It is further levered to the number of glasses of lemonade they order. A business could easily track this. If revenue began to fall, this should be evident in either the number of customers served or a decrease in the number of glasses of lemonade they order. Deeper KPI might break these customers into groups based on their purchasing behavior. All of this helps to “form” your understanding.
While I will skip the walk-through on cost-based KPI, they are equally important. You might also be considering things like pricing, or segments like time of day and location — all of these could be fair game. It all depends on the specifics of your lemonade stand.
One final consideration for individual metrics, be careful when using averages and ratios. Assume for a second that our stand decides to track glasses per hour or per customer. Each of these ratios can be insightful, but all ratios are bifurcated. Meaning that any ratio might move because of a change to the numerator or denominator or even a third factor not considered. Good KPI do not allow major trends to remain hidden.
Last, consider the interplay of all your KPI. No one metric is truly magic, though a powerful KPI can seem it. KPI are always a set of numbers, they will need to work in conjunction. Only together can they truly model the story of how your business is performing. Thanks for reading!
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