By David Parmenter
Key performance indicators (KPIs) in many organizations are a broken tool. Measures are often a random collection prepared with little expertise, signifying nothing. KPIs should be measures that link daily activities to the organization’s critical success factors (CSFs), thus supporting an alignment of effort within the organization in the intended direction.
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Myth #1: By Tying KPIs to Remuneration You Will Increase Performance
It is a myth that the primary driver for staff is money and that an organization must design financial incentives in order to achieve great performance. Recognition, respect, and self-actualization are more important drivers. In all types of organizations, there is a tendency to believe that the way to make KPIs work is to tie KPIs to an individual’s pay. But when KPIs are linked to pay, they create key political indicators (not key performance indicators), which will be manipulated to enhance the probability of a larger bonus.
KPIs should be used to align staff to the organization’s critical success factors and will show 24/7, daily or weekly how teams are performing. They are too important to be manipulated by individuals and teams to maximize bonuses. KPIs are so important to an organization that performance in this area is a given, or as Jack Welch says, “a ticket to the game.” Performance bonus schemes are often flawed on a number of counts. The balanced scorecard is often based on only four perspectives, ignoring the important environment and community and staff satisfaction perspectives. The measures chosen are open to debate and manipulation. There is seldom a link to progress within the organization’s CSFs. The damage done by such schemes is only found out in subsequent years.
The biggest culprit in unintended behavior has to be around performance-related pay. Never in the history of management has so little rigor been applied in such an important area. Performance bonuses give away billions of dollars each year based on methodologies to which little thought has been applied. Performance-related pay is broken both within the private sector and government and nonprofit agencies. Jeremy Hope puts it beautifully
in this quote:
…But despite hundreds of research studies over 50 years that tell us that extrinsic motivation (carrot and stick financial targets
and incentives) doesn’t work, most leaders remain convinced that financial incentives are the key to better performance.”
Jeremy Hope went on to say that performance-related pay remains one of the greatest barriers to transforming organizations. Bonus Schemes Should Not Be Linked to KPIs Performance-related pay schemes should not be linked to KPIs. KPIs are a special performance tool, and it is imperative that these are not included in any performance-related pay discussions. KPIs, as defined in Chapter 1, are too important to be gamed by individuals and teams to maximize bonuses. Performance with KPIs should be, as mentioned in Chapter 2, considered a “ticket to the game” and not worthy of additional reward. Although KPIs will show how teams are performing 24/7, daily, or weekly, it is essential to leave the KPIs uncorrupted by performance related pay. As mentioned in Chapter 2, it is a myth that by tying KPIs to pay you will increase performance. You will merely increase the manipulation of these important measures, undermining them so much that they will become Key Political Indicators.
Myth #2: You Can Delegate a Performance Management Project to a Consulting Firm
For the past 15 years or so many organizations have commenced performance measure initiatives, and these have frequently been led by consultants. Commonly, a balanced-scorecard approach has been adopted based on the work of Kaplan and Norton. The approach, as I will argue, is too complex and leads to a consultant-focused approach full of very clever consultants undertaking this exercise with inadequate involvement of the client’s staff. Although this approach has worked well in some cases, there have been many failures. The winning KPIs methodology clearly states, “You can do this in-house.” If you cannot, no one else can.
KPI projects are in-house projects run by skilled individuals who know the organization and its success factors. They have been unburdened from the daily grind to concentrate on this important project. In other words, these staff members have moved their family photographs, the picture of the 17-hand stallion or their beloved dog, and put them on their desks in the project office. Leaving the daily chore of firefighting in their sphere of operations to their second-in-charge who has now moved into the boss’s office, on a temporary basis of course!
Myth #3: All Measures Can Work Successfully in Any Organization, At Any Time
Contrary to common belief, it is a myth to think that all measures can work successfully in any organization, at any time. The reality is that there needs to be, as Spitzer has so clearly argued, a positive “context of measurement” for measures to deliver their potential. To this end I have established seven foundation stones that need to be in place in order to have an environment where measurement will thrive. These seven foundation stones are:
1. Partnership with the staff, unions, and third parties
2. Transfer of power to the front line
3. Measure and report only what matters
4. Source KPIs from the critical success factors
5. Abandon processes that do not deliver
6. Appointment of a home-grown chief measurement officer
7. Organization-wide understanding of winning KPI definition
For more of my research on these myths, download chapter 2 of my KPI book 3rd edition.
Myth #4: Most Measures Lead to Better Performance
Every performance measure can have a negative consequence or an unintended action that leads to inferior performance. Well over half the measures in an organization may well be encouraging unintended negative behavior. In order to make measures work, one needs to anticipate the likely human behavior that will result from its adoption, and endeavor to minimize the potential negative impact. KPIs are like the moon, they have a dark side. It is imperative that before a measure is used the measure is:
• Discussed with the relevant staff: “If we measure this, what will you do?”
• Piloted before it is rolled out.
• Abandoned if its dark side creates too much adverse performance.
Myth #5: We can set relevant year-end targets
Jeremy Hope, of Beyond Budgeting fame[i] was the first writer to clearly articulate that a fixed annual performance contract, such as the annual budgeting process, was doomed to fail. Hope and Fraser, pioneers of the Beyond Budgeting methodology, have pointed out the trap of the annual budget process. If you set an annual target during the planning process, typically 15 or so months before the last month of that year, you will never know if it was appropriate, given that the particular conditions of that year will never be guessed correctly. You often end up paying incentives to management when, in fact, you have lost market share. In other words, your rising sales did not keep up with the growth rate in the marketplace.
When we compare performance among peers and against external benchmarks, such as the market share, we are looking at relative performance targets measures. Thus, the financial institutions that are making super profits out of this artificial lower-interest-rate environment would have a higher benchmark set retrospectively, when the actual impact is known.
As Jeremy Hope points out, not setting an annual target beforehand is not a problem as long as staff members are given regular updates about how they are progressing against the rest of the market. He argues that if you do not know how hard you have to work to get a maximum bonus, you will work as hard as you can.
Myth #6: Devising appropriate performance measures is relatively simple
There will not be a reader of this paper who has not, at sometime in the past, been asked to come up with some measures with little or no guidance. Organisations, in both the private and public sectors, are being run by management who have not yet received any formal education on performance measurement. Yet many managers have been exposed to training in the basics of finance, human resources, and information systems and indeed, they are ably supported by qualified professionals. So much is known about these three disciplines where rigorous processes have been formulated, discussed and taught, performance measurement has only scant mention in the curriculum of business degrees and professional qualifications.
Performance measurement is worthy of more intellectual rigour in every organisation on the journey from average to good to great. Dean Spitzer[ii], an expert on performance measurement has suggested the appointment of a chief measurement officer who would be part psychologist, part teacher, and part salesman and part project manager. They would be responsible for the setting of all performance measures, the assessment of the potential ‘dark side’ of the measure, the abandonment of broken measures and the leader of all balanced scorecard initiatives. See the attached electronic media for a job description of the role.
Myth #7: KPIs are financial and non-financial indicators
I believe that there is not a financial KPI on this planet.
Financial measures are a quantification of an activity that has taken palace, we have simply placed a value on the activity. Thus, behind every financial measure is an activity. I call financial measures result indicators; a summary measure. It is the activity that you will want more or less of. It is the activity that drives the dollars, pounds, yen. Thus financial measures cannot possibly be KPIs.
When you put a pound or dollar sign to a measure you have not dug deep enough. Sales made yesterday will be a result of sales calls made previously to existing and prospective customers, advertising, amount of contact with the key customers, product reliability etc. I group all sales indicators expressed in monetary terms as result indicators.
This information has been extracted from David Parmenter’s Key Performance Indicators (4th Edition) which is the highest rated KPI book on Amazon.
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[i]. Jeremy Hope and Robin Fraser, “Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap” Harvard Business Press, 2003.
[ii] Dean Spitzer, “Transforming Performance Measurement: Rethinking the Way We Measure and Drive Organizational Success” AMACOM, 2007.