Both P3, Business Analysis, and P5, Advanced Performance Management, require candidates to be able to establish key performance indicators and critical success factors. For example, Question 1 of December 2011 P3 and Question 1 of December 2013 P5.
A surprising number of students do not feel comfortable with these terms, and this article is aimed at explaining and illustrating these concepts. In particular it will explain what is meant by:
- Critical success factors
- Performance indicators
- Key performance indicators
This can be defined as:
‘A task or operation seen in terms of how successfully it is performed’ (www.Oxforddictionaries.com).
Organisations differ greatly in which aspects of their behaviour and results constitute good performance. For example their aim could be to make profits, to increase the share price, to cure patients in a hospital, or to clear household rubbish. The concept of ‘performance’ is very relevant to both P3 and P5. P3 looks at how organisations can make decisions that improve their strategic performance and, of course, P5 is called ‘Advanced Performance Management’ and is focused on how organisations evaluate their performance.
The primary required tasks are often found in the organisation’s mission statement as it is there that the organisation’s purpose should be defined. These are called ‘primary required tasks’ because although the primary task of a profit-seeking business is to make profits, this rests on other subsidiary tasks such as good design, low cost per unit, quality, flexibility, successful marketing and so on. Many of these are non-financial achievements.
Some aspects of performance are ‘nice to have’ but others will be critical success factors. For example, the standard of an airline’s meals and entertainment systems will rank after punctuality, reliability and safety, all of which are likely to be critical to the airline’s success.
Objectives are simply targets that an organisation sets out to achieve. They are elements of the mission that have been quantified and are the basis for deciding appropriate performance measures and indicators. There is little point measuring something if you do not know whether the result is satisfactory and cannot decide if performance needs to change. Organisations will create a hierarchy of objectives which will include corporate objectives which affect the organisation as a whole and unit objectives which will affect individual business units within the organisation. Even here objectives will be categorised as primary and secondary, for example an organisation might set itself a primary objective of growth in profits but will then need to develop strategies to ensure this primary objective is achieved. This is where secondary objectives are needed, for example to improve product quality or to make more efficient use of resources.
Objectives often follow the SMART rule. They should be:
Specific: there is little point in setting an objective for a company to improve its inventory. What does that mean? It could mean that stock-outs should be less frequent, or average stock holdings should be lower, or the inventory will be held in better conditions to reduce wastage.
Measurable: if you can’t measure something you will be at a loss as to how to control it. Some aspects of performance might be difficult to measure, but efforts must be made. Customer satisfaction is important to most businesses and indications could be obtained by arranging customer surveys, repeat business and so on.
Achievable/agreed/accepted: objectives are achieved by people and those people must accept and agree that the objectives are achievable and important.
Relevant: relevant to the organisation and the person to whom the objectives are given. It is important that people understand how achieving an objective will help organisational success. If this connection isn’t clear, employees will begin to feel that the objective is simply a cynical exercise of management power. The person to whom the objective is given must also feel that they can affect its achievement.
Time-limited: all objectives have to be achieved within a specified time period otherwise procrastination will rule.
Critical success factors
A critical success factor (CSF) can be defined as:
‘An area where an organisation must perform well if it is to succeed.’
Alternatively, Johnson, Scholes & Whittington defined CSFs as:
'Those product features that are particularly valued by a group of customers, and, therefore, where the organisation must excel to outperform the competition.’
This definition is more complex than the first, but it is more useful because it makes the organisation look towards its customers (or users) and recognises that their opinion of excellence is more important and reliable than internally generated opinions. If an organisation doesn’t deliver what its customers, clients, patients, citizens or students value, it is failing.
Performance indicators and key performance indicators
Performance indicators (or performance measures) are methods used to assess performance. For example:
In profit-seeking organisations:
- Earnings per share
- Return on capital employed
In not-for-profit organisations:
- Exam grades (a school)
- Waiting times for hospital admission (a health service)
- Condition of roads (a local government highways department)
Particularly in profit-seeking organisations, the prime financial performance indicators allow performance to be measured but they say little about how that performance has been achieved. So, high profits will depend on a combination of good sales volumes, adequate prices and sufficiently low costs. If high profits can only be achieved by a satisfactory combination of volume, price and cost, then those factors should be measured also and will need to be compared to standards and budgets.
Similar effects are found in not-for-profit organisations. For example, in a school, a CSF might be that a pupil leaves with good standards of literacy. But that might depend on pupil-teacher ratios, pupils’ attendance and the experience of the teachers. If these factors contribute to good performance, they need to be measured and monitored.
Just as CSFs are more important than other aspects of performance, not all performance indicators are created equal. The performance indicators that measure the most important aspects of performance are the key performance indicators (KPIs). To a large extent, KPIs measure how well CSFs are achieved; other performance indicators measure how well other aspects of performance are achieved
There are a number of potential pitfalls in the design of performance indicators and measurement systems:
- Not enough performance measures are set
Often, directors and employees will be judged on the results of performance measures. It has been said that ‘Whatever gets measured gets done’ and employees will tend to concentrate on achieving the required performance where it is measured. The corollary is that ‘Whatever doesn't get measured doesn't get done’ and the danger is that employees will ignore areas of behaviour and performance which are not assessed.
- Too many performance indicators
This occurs especially where performance measures are not ranked by importance and none have been identified as KPIs. Performance indicators have to be measured, calculated and reported to management, and discrepancies must be explained or excuses invented. Too many measures can divert time from more important tasks and there is a danger that employees concentrate on the easier but more trivial measures than on the more difficult but vital targets.
- The wrong performance measures
An example of this would be applying strict cost measures in an organisation where luxury products and services are sold (a differentiation strategy). This is likely to detract from the organisation’s strategic success.
- Too tight/too loose performance measures
Performance indicators that are too difficult to attain can lead to a loss of employee motivation and promote dysfunctional behaviours such as gaming and the misrepresentation of data. Performance measures that are too loose can pull down performance. Benchmarking can help to avoid this. Internal benchmarking generally sets measures based on previous period’s measures or set measures with respect to other branches or divisions. However these internal benchmarks can lead to complacency as many organisations have to compete with others and benchmarks should be aligned to competitors’ performance.
- ‘Hit and run’ performance indicators
This means that a performance indicator is set and then it is assumed that things will look after themselves. Performance indicators need a management framework they are to be at all effective.
Performance measures – a practical framework
Expanding on the last point, above, to establish a performance measurement system, something like the following is needed for each measure:
- A meaningful title of the measure
- What is its purpose and how does that purpose relate to strategic success?
- What other performance measures might be affected by this one, how are they affected and how are conflicts to be resolved?
- Who will be held responsible for it?
- What is the source data, who is responsible for its supply, how is it measured and how is the measure calculated?
- What investigations and explanations are required and who is responsible?
- What target is set and how has that target been determined?
- How often should the target be updated?
- How often is the measure reported on?
- Reporting and action?
For example, consider a passenger train company called TTTE:
1. Title of performance measure
Punctuality (the percentage of trains arriving at their destination on time).
2. Purpose of performance measure
TTTE’s strategic objective is to provide comfortable, reliable and punctual services to passengers. TTTE competes with other train companies, cars, buses and airlines. Punctuality is seen as a key competitive lever and therefore must be measured.
3. Other performance measures affected
Safety – safety checks and speed limits will take priority over punctuality
Cleanliness – it might be necessary to occasionally reduce cleaning to keep to the timetable.
Energy consumption running a train faster than normal (though within speed limits) will cause higher fuel consumption but punctuality takes precedence.
4. Who is held responsible?
5. Source data, measurement and calculation of the measure.
The duty manager at each station is responsible for logging the arrivals time of each train. A five-minute margin is allowed ie a train is logged ‘on time’ if it is no later than 5 minutes after the advertised time. Beyond five minutes the actual time by which the train is late is logged. Results will be calculated in percentage bands: on time, up to 15 minutes late, >15–30 minutes late, >30 minutes – one hour late, >one hour late, and so on.
6. Investigations and explanations
While logging late arrivals, station duty managers should also note the cause where possible. The operations director must collate this information using statistical analysis which highlights persistent problems such as particular times of the day, routes or days of the week.
7. Target and how it is determined
The target is dictated by the railway timetable. The timetable should be reviewed twice a year to look for ways of reducing journey times to keep TTTE competitive with improvements in competing transport.
8. Update of target
The banding and any tolerances will be updated annually.
9. How often should the measure be reported
10. Reporting and action
The operations director will report performance on a monthly basis to the board together with plans for service improvement.
Use of performance indicators in the P3 and P5 syllabuses
Performance indicators are relevant to the following models and theories:
Mission statements: these define the important aspects of performance that sum up the purpose of the organisation. See the article ‘Reports for performance management’ (see 'Related links').
Stakeholder analysis: recognises that different stakeholders have different views on what constitutes good performance. Sometimes what stakeholders want is different to what the mission statement suggests as the purpose of the organisation. This can be a particular problem when the stakeholders are key-players.
Generic strategies: the main generic strategies to achieve competitive advantage are cost leadership and differentiation. If a company’s success depends on being a cost leader (a CSF) then it must carefully monitor all its costs to achieve the leadership position. The company will therefore make use of performance indicators relating to cost and efficiency. If a company that has chosen differentiation as its path to success then it must ensure that it is offering enhanced products and services and must establish measures of these.
Value chain: a value chain sets out an organisation’s activities and enquires as to how the organisation can make profits: where is value added? For example, value might be added by promising fantastic quality. If so, that would be a CSF and a key performance indicator would the rate occurrence of bad units.
Boston consulting group grid: this model uses relative market share and market growth to suggest what should be done with products or subsidiaries. In P3 if a company identifies a product as a ‘problem child’ BCG says that the appropriate action for the company is either to divest itself of that product or to invest to grow the product towards a ‘star’ position on the grid. This requires money to be spent on promotion, product enhancement, especially attractive pricing and perhaps investment in new, efficient equipment. In P5 the model would be used to establish how to manage the performance of the products and what measures should be used depending on their position in the grid. For example, good performance for a star would be measured by market share growth rather than profits. Return on investment could be low until full use is made of the new equipment. Once a product reaches its ‘cash cow’ stage performance measures will focus on revenues, costs and profits.
PESTEL and Porter’s five forces: both the macro-environment and competitive environment change continuously. Organisations have to keep these under review and react to the changes so that performance is sustained or improved. For example, if laws were introduced which stated that suppliers should be paid within a maximum of 60 days, then a performance measure will be needed to encourage and monitor the attainment of this target.
Product life cycle: different performance measures are required at different stages of the life cycle. In the early days of a product’s life, it is important to reach a successful growth trajectory and to stay ahead of would-be copycats. At the maturity stage, where there is great competition and the market is no longer growing, performance will depend on low costs per unit and maintaining market share to enjoy economies of scale.
Company structure: different structures inevitably affect both performance and its management. For example as businesses become larger many choose a divisionalised structure to allow specialisation in different parts of the business: manufacturing/selling, European market/Asian market/North American market, product type A/product type B. Divisional performance measures, such as return on investment and residual income, then become relevant
Information technology (IT): new technologies will influence performance and could help to more effectively measure performance. However, remember that sophisticated new technology does not guarantee better performance as costs can easily outweigh benefits. If IT is vital to a business then downtime and query response time become relevant as might a measure of system usability.
Human resource management: what type of people should be recruited, and how are they to be motivated, appraised and rewarded to maximise the chance of good organisational performance? Performance measures are needed, for example, to monitor the effectiveness of training, job performance, job satisfaction, recruitment and retention. In addition, considerable effort has to be given to considering how employees’ remuneration should be linked to performance.
Fitzgerald and Moon building blocks
Section E(1) of the P5 study guide mentions three specific approaches or models:
- Balanced scorecard
- Performance pyramid
- Fitzgerald’s and Moon’s building blocks
The balanced scorecard approach is probably the best known but all seek to ensure that the net is thrown wide when designing performance measures for organisations so that factors such as quality, innovation, flexibility, stakeholder performance, and delivery and cycle time are listed as being important aspects of performance. Whenever an aspect of performance is important then a performance measure should be designed and used.
The Fitzgerald and Moon model is worth a specific mention here as it is the only model which explicitly links performance measures to the individuals responsible for the performance.
The model first sets out the dimensions (split into results and determinants) where key performance indicators should be established. You will see there is a mix of financial and non-financial, and both quantitative and qualitative:
- Financial performance
- Competitive performance
- Resource utilisation
The model then suggests standards for KPIs:
- Ownership: refers to the idea that KPIs will be taken more seriously if staff have a say in setting targets. Staff will be more committed and will better understand why that KPI is needed.
- Achievability: if KPIs are frequently and obviously not achievable then motivation is harmed. Why would staff put in extra effort to try to achieve a target (and bonus) if they believe failure is inevitable.
- Fairness: everyone should be set similarly challenging objectives and it is essential that allowance should be made for uncontrollable events. Managers should not be penalised for events that are completely outside everyone’s control (for example, a natural disaster) or which is someone else’s fault.
The model then suggests how employee rewards should be set up to encourage employees to achieve the KPI targets:
- Clarity: exactly how does performance translate into a reward?
- Motivation: the reward must be both desirable and must be perceived as achievable if it is to be motivating.
- Controllable: achievement of the KPI giving rise to the reward should be something the manager can influence and control.
Ken Garrett is a freelance lecturer and writer