The Emperor’s New Clothes (About KPIs)

Posted by on Jan 28, 2014 in Drivers of Cash Flow

The truth is in the cash flow

The Emperor’s New Clothes (About KPIs)

I recently read an interesting article on Key Performance Indicators (KPIs) by the economics journalist, Ross Gittens, which prompted me to consider when and how KPIs are best used. I thought I would share my conclusions in this post.

Key Performance Indicators (KPIs) are an established part of the business world, used in many organisations whether operating in the public or the private sector, often to encourage particular employee behaviour and focus, and as an objective means of measuring and ranking performance with consequences for employee remuneration.

They are quantitative or qualitative measures used to review an organisation’s progress against its goals. They may be broken down and set as targets for achievement by departments and individuals. The achievement of these targets is then regularly reviewed.

As such, KPIs immediately meet three of the criteria needed for setting effective goals, in that they are specific, measurable and time bound. Depending on where the benchmark is set, KPIs will also meet the other two criteria for setting effective goals, being that they are also attainable and realistic.

No wonder then that their use in business is extensive.

What about the disadvantages of using KPIs? From the article written by Gittens it is clear that he is not a fan of KPIs. The summary of his misgivings on KPIs is that they can be manipulated. He argues that most jobs are multi-dimensional, and that you cannot construct a KPI covering every dimension – hence the manipulation occurs by cannibalising some dimension of a job (usually quality related) not covered by a KPI. In other words, KPIs are usually capable of only measuring quantity, but not quality.

Hmm, quite the conundrum. On one hand, we have an established business practice that has been widely used for many years. On the other, an argument that says KPIs are simplistic in nature and open to manipulation.

So, are KPIs really useful, or a dangerous fad, a modern-day business-related take on “The Emperor’s New Clothes”?

I think the answer to that question lies in the implicit assumption of the Gittens article, which is that employees are motivated to manipulate imperfect measures of complex real world relationships by the linking of their remuneration to the KPI outcome. But, does this mean KPIs should be abandoned?

What about the SME Owner? Are KPIs useful to them? My conclusion is absolutely Yes, and I think this because:

there is no motivation for the SME Owner to manipulate KPI outcomes, as there is no benefit to them to see the position of their business other than as it actually is; and

after many discussions with SME owners, I know that most use some type of Rule of Thumb measures (at least) to give them a sense of how the business is operating.  

My position is that whilst there may be some flaws to using KPIs at the employee level, they are capable of providing useful and important signals to the SME Owner about the health of their business.

This led me to another train of thought, what are the best KPIs for SME Owners to use? Is there a set of “universal” KPIs that are capable of providing useful and important signals for all SME Owners?

I think there is and in my next post, I will share with you my ideas on a set of universal KPIs for the SME Owner. You will discover that these KPIs are easy to measure; capable of being adapted and used by a wide variety of business; represent activities that directly affect the amount of cash that a business produces; are readily influenced by the decisions and actions of the Business Owner; and help identify potential deterioration in the major cash-flow generating operations of the business.