Transcript of "Enhance Competitive Performance via Critical Key Performance ..."
Enhance Competitive Performance via Critical Key
Performance Indicators (KPIs)
by Zahirul Hoque
• Measuring performance is a fundamental part of every organization, whether it is run by a private
sector or a government sector.
• Performance measures are used to evaluate organizational as well as managerial performance.
• A key performance indicator (KPI) is a quantitative value that can be scaled and used for performance
• Organizations should use both financial and nonfinancial KPIs when measuring employee as well as
• KPIs should be aligned with business strategy, work environment, and employee incentives.
• Too many KPIs should be avoided, to maximize their usage by employees in their day-to-day
• “It is much more difficult to measure nonperformance than performance.”
Measuring performance is a fundamental part of every organization, whether it is run by a private sector or
a government sector. A performance measurement system (PMS) highlights whether the organization is on
track to achieve its desired goals. Performance measures are primarily used to evaluate organizational, as
well as employee performance. A PMS develops key performance indicators (KPIs), or metrics, depending
on the nature and activities of the organization. KPIs can serve as the cornerstone of an organization’s
employee incentive schemes. KPIs are used as guidelines and incentives to facilitate the coordination of
managers and business unit goals, with those of the overall corporation goals, that is, they encourage goal
congruency. Through these metrics, the organization communicates how it wishes the employees to behave,
and how this behavior will be judged and evaluated. Effective organizational managers rely on KPIs to set
direction, make strategic decisions, and achieved desired goals.
It has been suggested that, in today’s competitive and global financial crisis environments, organizations
need to be masters at anticipating customers’ needs, devising radical new product and service offerings, and
rapidly deploying new production technologies into operating and service delivery processes. For several
decades, performance measurement has been used as an internal informational tool to evaluate business
units’ operations, and make program and budgetary decisions.
PMS and KPIs: Definitions
A PMS typically comprises systematic methods of setting business goals, together with periodic feedback
reports that indicate progress against those goals. Within a PMS, an organization develops some key
performance metrics or indicators. A KPI can be defined as “a quantitative value that can be scaled and used
for purposes of comparison.” There is also the view that KPIs are quantifiable performance measurements
used to define success factors, and measure progress toward the achievement of business goals.” The
PMS literature classifies performance measures into two major groups: financial and non-financial. Financial
measures may include return on investment (ROI), earnings per share (EPS), revenue (sales) growth, profit
margin, etc. Non-financial measures may include customer satisfaction, employee satisfaction, production
efficiency, quality, customer services, etc.
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Balanced Scorecard Measures
In today’s competitive environment, one that encompasses fierce global competition, advancing technology,
and increased customer awareness, traditional KPIs such as ROI and EPS can be inadequate for a business
organization. Traditional KPIs. although they can aid in detecting weaknesses with respect to the use,
or non-use of individual investment or assets, and focus management’s attention upon earning the best
profit possible on the capital available, tend to avoid isolating individual business units, in that it may not be
reasonable to expect the same ROI for each unit. If the unit sells its respective products in markets that differ
widely, with respect to product development, competition, and customer demand, lack of agreement on the
optimum rate of return might discourage managers who believe the rate is set at an unfair level.
For the sake of making the current period performance measure look good, be it ROI or EPS, managers
may be influenced to make decisions that are not in the best long-run interests of the firm. A major
concern with traditional KPIs is that these performance metrics focus on results largely internal to the firm.
During the last decade, there has been an overemphasis on the use of financial KPIs to measure firm
performance. This has resulted in organizations losing sight of important indicators which measure levels
of customer satisfaction, process flexibility, or adaptation in response to changing needs. A strategy which
concentrates on financial criteria is too closely related to short-term profit maximization. Broader measures
such as customer-based measures, product and process measures, and continual improvement and
innovation measures, enable the organization to establish longer-term improvements which further effective
Further, the imperative for improved performance measures cannot be ignored with today’s worldwide
competition and advancing technologies. Once new technologies are introduced, major organization
changes are required, as the interaction between people and technology is essential to ensure business
processes become more and more effective, and, therefore, performance measures which focus only on
financial criteria will not reflect the new technological and competitive environments. New performance
measures, if devised strategically, will profoundly influence business performance. Thus, more attention
also needs to be placed on generating suitable non-financial performance measures to be a successful
competitor, given today’s global financial crisis. Significant attention is now being given by academics and
managers to building a more extensive and linked set of measures for appraising and directing corporate and
divisional performance, influenced largely by Kaplan and Norton’s notion of the “balanced scorecard”.
The balanced scorecard approach focuses on both financial and non-financial measures. The financial
measures indicate if improvements in financial performance resulted from sacrificing investments in new
products, or on-time delivery. The balanced scorecard includes financial measures that tell the results
of actions already taken. Kaplan and Norton suggest that financial measures should not be eliminated
altogether, because a well-designed financial performance measurement system can actually enhance,
rather than inhibit an organization’s management program. The balanced scorecard supplements the
financial measures with operational measures on customer satisfaction, internal processes, and the firm’s
innovation and improvement activities. Kaplan and Norton’s balanced scorecard comprises the following four
• Financial—applying appropriate financial performance measures to ascertain whether the company is
• Customer—assessing customer satisfaction (the customer perspective). In a competitive market,
customers must be content, or market share will drop. Customers care about price, faster and reliable
deliveries, design, quality, and level of services.
• Internal business processes—tracking inter-organizational indicators to determine whether the
business units are efficiently using resources, and ascertaining competitive performance in developing
“next generation” products.
• Learning and growth dimension—this measures such things as training and development, information
systems, employee satisfaction, employee productivity, etc.
Kaplan and Norton suggest that the use of the balanced scorecard may motivate breakthrough
improvements in critical activity areas such as products, processes, customers, and market developments.
They further suggest that, while traditional financial measures report on what happened in the last period
without indicating how managers can improve performance in the next, the balanced scorecard functions as
the cornerstone of a company’s current and future success.
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Table 1 provides examples of widely used KPIs within a PMS in a manufacturing setting.
Table 1. KPIs in a PMS within a manufacturing setting
Financial Operating income Sales growth Return on
investment Earnings per share
Customer Market share Customer response time On-time
delivery Number of customer complaints Number of
warranty claims Customer satisfaction survey Sales
return due to poor quality
Internal business processes Material efficiency variance Labor efficiency Ratio
of good output to total output at each production
process Rate of material scrap loss Number of new
patents Number of new product launches
Employee learning and growth Employee satisfaction survey Employee education
and training Employee health and safety
Aligning KPIs and Strategy
Omega is a water utility company that provides five core services to its customers, namely bulk water supply,
water purification, reticulation of water and wastewater treatment, and wastewater disposal. On average,
Omega provides services to more than 157,000 residential properties. In July 2003, Omega introduced
a multidimensional PMS to improve accountability, and to communicate to organizational members the
objectives and targets of the entity. As shown in Table 2, Omega developed a total of 33 KPIs for each of
its six major activities. Table 2 shows this new KPI system, which, consistent with the balanced scorecard,
combines a series of non-financial and financial KPIs. According to Omega’s senior management, one
of the advantages of adopting a multidimensional PMS is that it gives a better indication to employees of
the long-term organizational priorities. It also helps to communicate any crisis to all of Omega’s divisions,
which was important to ensure that any impact is minimized. Each KPI is tailored, not to a division but to
one of the five major activities of Omega, consistent with its attempts to become more outcome-focused.
For instance, the percentage of lost working days or absentees is aimed at measuring Omega’s ability to
be a chosen employer. Similarly, the return on net operating assets is a new KPI, which is used to measure
the commercial sustainability of Omega. In setting the KPIs, Omega employees suggested that it was
common when the information was available to benchmark against other water entities, to ensure that the
divisions are providing a service at a similar standard as their private and public counterparts, so that they
are not seen to be performing poorly when the contractual period ends. Some of Omega’s subdivisions also
suggested that this had put the division under pressure to improve its performance.
Table 2. KPIs of Omega
Major strategic focus KPIs
Customer focus % Customer satisfaction % Compliance with verbal
service-request response times Number of water
supply interruptions per 1,000 properties Number
of planned water supply interruptions per 1,000
properties Number of unplanned water supply
interruptions per 1,000 properties % of water and
wastewater service interruptions within 5 hours
Number of customer complaints per 1,000 properties
Number of water quality complaints per 1,000
properties Number of odor complaints per 1,000
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properties % of meters installed within 14 days from
date of payment
Chosen employer % lost working days Training expenditure versus
total operating expenditure (%)
Environmental sustainability % tests meeting WWTP EPA license criteria Quantity
of treated water supplied per property, not seasonally
adjusted Number of uncontained wastewater spills %
of wastewater spilt per wastewater treated % effluent
Commercial sustainability Combined operating costs per property % expended
of revenue-funded capital expenditure Water and
wastewater renewals expenditure as a percentage
of current replacement cost of system assets %
unaccounted water Operating profit Return on
turnover (net profit after tax/sales) Return on net
operating assets (EBIT/total net assets) Debt-equity
ratio (total interest-bearing debt/total equity) Total
financial distribution to council (as a % of post-tax
Quality water service provision % tests meeting NHMRC (1996) bacteria criteria %
tests meeting NHMRC (1996) chemical criteria Water
main breaks per 100km of water main Sewer chokes
per 100km of wastewater main Wastewater main
(gravity and pressure) breaks per 100km of main
Accountability % Compliance with wastewater spillage procedure
(ensures spillages are properly reported and
remedied) Maintenance of ISO 9000 and 14000
An English-born American communications executive, who was president and CEO of ITT, suggests that,
“the best way to inspire people to superior performance is to convince them by everything you do and by
your everyday attitude that you are wholeheartedly supporting them.” This short article suggests that
measuring performance is important for all businesses. However, it is much more difficult to develop KPIs
for each area of performance within the organization which can be measured effectively. Effective KPIs are
those that enhance business performance in all areas of businesses—financial and non-financial. Harold
Green remarks: “Performance stands out like a ton of diamonds. Non-performance can always be explained
away.” KPIs need to be developed to fit to the business process flow, and focus attention on the critical
success factors of the business.
Making It Happen
Developing KPIs is a critical decision-making process for any organization. Effective KPIs are those
that help the organization to achieve its desired outcomes. Performance indicators must advocate the
firm’s internal and external environment. However, for many firms the difficulty is that there are too many
KPIs, ones that are outmoded, and that are not harmonious. KPIs should observe changes in the market
environment, determine and assess progress towards business strategies and goals, and affirm achievement
of performance goals. This is elaborated in turn. Robert Simon at Harvard University developed three tests to
assess whether a measure or metric is suitable to support a performance goal.
1. Does the KPI align with business strategy?
2. Can it measured effectively (that is, metrics should be objective, complete and responsive)?
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3. Is the measure linked to economic value?
According to Robert Simon (2000, p.239): “To be effective as communication devices, managers must use
measures to focus attention. As you all know, what gets measured gets managed.”
Linking KPIs to Business Strategy and Competitive Environments
Strategy plays an important role in the choice of KPIs, and effective KPIs must be able to assess the
organization’s progress on strategic priorities. Business strategy has been broadly conceptualized as a
continuum spectrum between two extreme orientations: at one extreme, prospector or differentiator firms;
and at the other end, defender or cost-leader firms. However, some business units may stand between both
defenders and prospectors, which are often refereed to as “analyzers.”
As defender or cost leaders focus on searching for new ways to reduce production and distribution costs,
to cut marketing expenses, and to improve product quality, short-term, retrospective financial and efficiency
indices (for example, cost control, internal business processes, quality and efficiency, operating profit, cash
flow from operations, return on investment, etc) are relatively informative KPIs of performance. In contrast,
as prospectors or differentiators compete in a broad product market domain by introducing new products and
developing new markets, KPIs for focuses such as these would necessarily come from knowing what the
customer wants, the level of staff involvement in creativity, and the ability of the organization to produce and
market new products. Hence, a greater usage of non-financial KPIs (for example, new product development,
market share, and customer satisfaction), as opposed to short-term financial indicators, would be prominent
in this type of firm.
Analyzer strategies combine both defender and prospector strategies. As a result, an analyzer firm’s
organizational problem is how to accommodate both stable and dynamic areas of operations. The first
concentrates on being efficient, and the second concentrates on watching its competitors closely, so as to
determine the possibility of introducing new products or services as rapidly as possible. In relation to the first
area, analyzers may tend to emphasize stability, defense of the firm’s position in the market, and to earn the
best profit possible. The key rationale being that too many firms are able to provide the same product at the
same price, hence the incentive to increase sales, or the profit margin, is to ensure its internal processes
are acting as efficiently and cost-effectively as possible. As a result, analyzers may place emphasis on
short-term, financial KPIs. The second area focuses on new market opportunities by developing new brands
in response to emerging environmental trends. Consequently, the level of uncertainty would be high in
organizations pursuing analyzer strategy. Consistent with this strategic position, analyzers are also likely
to rely more on non-financial KPIs. Thus, since analyzers operate in two combined market areas, these
firms would then be more prone to incorporate a much broader range of KPIs, such as that required by
the balanced scorecard. It is felt that for analyzers, four dimensions of the balanced scorecard, as outlined
above, can be regarded as meeting organizational performance measurement requirements, as they provide
useful insights into the firm’s performance evaluation paradox in one report. In conclusion, different types of
strategy will require different types of PMS and KPIs, and an appropriate fit between PMS and strategy is
likely to enhance a firm’s performance.
Aligning KPIs and Incentives
Are KPIs linked to employee incentives? If KPIs are not linked to employee incentive schemes they tend to
be overlooked by employees and therefore they are likely to result in no desired outcomes. KPIs must be
aligned with employees’ individual goals and job descriptions. As a rule of thumb, Robert Simon suggested
a maximum of 10 KPIs for each individual; otherwise individuals may suffer from information overload.
With a reasonable number of KPIs, at the individual level, employees use KPIs to track their performance
against agreed targets. Further, when developing KPIs for individuals, financial indicators should integrate
nonfinancial or operational indicators on customer satisfaction, internal processes and the firm’s innovation
and improvement activities.
Implementation of KPIs
Organizations also need to place greater emphasis on implementation issues when designing and
implementing a PMS, and relevant KPIs. A recent study in Australia identified several factors (such as top
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management support, adequate technology, greater employee involvement in the design stage, adequate
staff training and education, and linking PMS and KPIs with other financial control models) that impact on the
successful implementation of a new PMS.
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1 Simon (2000), p.3.
2 Kaplan and Norton (1996).
3 Simon (2000), p.7.
4 Ibid., p.234.
5 See www.bettermanagement.com/topic/subject.aspx?f=11&s=704, accessed on February 11, 2009.
6 Based on Moll, J. and Z. Hoque. “New organizational forms and accounting innovation: The specifier/
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8 For further details, refer to Simon (2000), pp.234–238.
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• Multidimensional Performance Measurement Using the Balanced Scorecard
• Navigating a Liquidity Crisis Effectively
• Assessing Business Performance
• Understanding Key Performance Indicators
• Understanding the Balance Sheet
• Using and Understanding Financial Ratios for Analysis
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