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How to Define the Right Metrics for Performance Management

Michael Smith

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How Good Are Most Companies at Selecting the Right Performance Metrics?

Companies that validate a causal model (cause & effect relationships) between operational performance measures and financial results achieve: 2.95% higher Return on Assets 5.14% higher Return on Equity However only 23% of companies have a developed causal model

How do you know which business metrics drive value?

Key Issues
1. How business and IT leaders can leverage information for financial benefit? 2. What is the relationship between performance measures and financial results, and which performance measures we should focus on? 3. What roles within IT and the business can facilitate the use of performance metrics to successfully execute the business strategy being followed?

An Integrated Business Intelligence and Performance Management Framework


Business-Centric

Business Strategy
Performance Management

Performance Management
Delivers shared management view into multiple levels of information/analysis across multiple planning, execution and decisions cycles Strategy driven

BI Competency Center

People

Process

Analytic Applications

Analytic Applications
Provides users with analysis of information for business transformation/ improvement Process-driven analytic applications (also known as analytics) Analyst-driven analytic applications (also known as BI)

BI Platforms Information Management Infrastructure


IT-Centric

Issues Requiring Improvements in Performance Management

What is the root cause of these issues?

Metrics Should Be Organized Into Three Levels


Organizing Your Metrics Into Three Levels Makes Them Easier To Use

1. Accounting Metrics 2. Performance Metrics 3. Analytical Metrics

Regulated Metrics Industry Standard Non-Regulated Performance Metrics Company Specific Metrics
Example: Gartner Business Value Model

What are some examples of Performance Metrics?

Accounting Metrics Explain Less And Less Of The Full Story


Value ($ millions)
$14,000,000 $12,000,000 $10,000,000 $8,000,000 $6,000,000 $4,000,000 $2,000,000 $0 1978 '80 '85 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 2006

Book to Market Value S&P 500


Year

Book Value

Market Value

Earnings

Measurement Gap

The Enhanced Business Reporting Consortium in the U.S. http://www.ebr360.org The Operating and Financial Review Initiative in the U.K. http://www.co3.coop/subpage.asp?id=45&mainid=18

How to Select the Right Metrics


Best Practices:
1. Leading indicators of financial results 2. Collectively exhaustive and mutually exclusive 3. Less is more 4. Hierarchical and functional 5. Standards-based 6. Flexible aggregates and primes 7. Holistic, to avoid local optimization 8. Practical, based on available data 9. Evolutionary learn from the Financial Accounting Standards Board

Leading Indicators That Drive Positive Change


Best Practice:
1. Leading indicators that drive positive change
Financial Metrics Income Statement ($ million) Revenue $1,000 Less: Cost of Goods Sold 500 Gross Profit 500 Business Performance Metrics Business Performance Framework Sales Opportunity Index, Time to Market Procurement Costs, Conversion Costs Customer Retention, Sales Close Index Service Performance, Support Performance, New Projects Index, Advisory Index

Less Operating Expenses: Sales 200 Administrative 200 Net Income

$100

Measuring the Real Drivers of Business Value


Best Practice:
2. Collectively exhaustive and mutually exclusive
Corporate
Financial Metrics

Business Units P&Ls

BU 1
KPIs KPIs

BU 2
KPIs KPIs

BU 3
KPIs KPIs

Business Functions

Marketing

Operations

Marketing

Operations

Marketing

Operations

Key Performance Indicators Key Performance Indicators

Key Performance Indicators Key Performance Indicators

Business Operations

Op. 1

Op. 2

Op. 3

Op. 4

Op. 5

Op. 6

Op. 7

Op. 8

Op. 9

Let's look at an example of a metrics that meet these criteria

The Gartner Business Value Model Is A Good Starting Point


Gartner Business Value Model
Sales Effectiveness
Demand Management Supply Management Support Services Sales Opportunity Index Sales Price Index On-Time Delivery Service Performance Systems Performance Service Level Effectiveness
Market Responsiveness Customer Responsiveness Human Resources Responsiveness Sales Effectiveness Supplier Effectiveness Information Technology Responsiveness Product Development Effectiveness Operational Efficiency Finance and Regulatory Responsiveness

Sales Cycle Index Forecast Accuracy Order Fill Rate Agreement Effectiveness IT Support Performance New Projects Index

Sales Close Index Customer Retention Index Material Quality Transformation Ratio Partnership Ratio IT Total Cost Index

Customer Responsiveness Information Technology Responsiveness

Identify relevant metrics to be tracked and communicated

(see "The Garter Business Value Model," G00139413)

What Exactly Does the Research Cover?


Guiding Principles Metric Definitions Applications Implementation advice Cause and effect relationships

Each metric is linked numerically to a balance sheet or income statement account.

Balance Balance Sheet Sheet

Income Income Statement Statement

Applications of Performance Metrics


Planning The process of creating a set of business activities or objectives that support a business strategy. Performance

Metrics

Forecasting Extrapolating new versions of plans and budgets based on the analysis of historical data. Budgeting Involves defining a short-term, financially oriented plan, which sets financial targets for revenue, expenditure and cash generation.

Using Metrics in Strategic Planning


Define Strategic Intent
The Business Strategy
Low-cost, high-quality provider Customized services delivered quickly Innovative products addressing new needs

Alignment
Define Strategic Objectives
The Business Objectives
Increase store volumes Develop a Web-based order process Improved product development

Identify Performance IT Metrics Strategy & Objectives The Business


Metrics
Asset Utilization Customer Retention Configureability Index Time-toMarket

The IT Strategy
Influence planning process Re-prioritize existing portfolio Reduce response time Improve IT skills

Measures of IT Performance
The IT Metrics
Agreement effectiveness New projects index System performance Skills inventory index

So What's the Problem?

An Example of Using Metrics in Strategic Planning


Business Strategy: Customized products delivered quickly at a reasonable price Business Objectives: Develop a Web-based order fulfillment process tied to pre-configured product options
Target Market Market Coverage Market Share Index Index Index Product Portfolio Channel Configure-ability Index Profitability Index Index Sales Opportunity Sales Cycle Sales Close Index Index Index Sales Effectiveness Cost of Sales Forecast Customer Index Accuracy Retention Index Product Develop- New Products Feature Function Time to Market ment Effectiveness Index Index Index On-Time Order Fill Material Delivery Rate Quality Customer Responsiveness Service Customer Care Agreement Performance Performance Effectiveness Supplier OnSupplier Order Supplier Material Time Delivery Fill Rate Quality Supplier Effectiveness Supplier Service Supplier Care Supplier AgreePerformance Performance ment Effectiveness Operational Cash to Cash Conversion Asset Efficiency Cycle Time Cost Utilization Market Responsiveness Opportunity/ Threat Index

Identify Performance Measures to Monitor Business Success: Present customer options Maximize customer control Maximize customer loyalty Maximize customer information Immediate cash receipts Assemble to order, purchase to order

Sales Price Index

R&D Success Index Service Accuracy Transformation Ratio Supplier Service Accuracy Supplier Transformation Ratio Sigma Value

And How Are Initiatives Evaluated?

An Example of Using Metrics in Budgeting: Automotive Supplier


Problem: Custom products were a loss leader for the standard product line. Solution: Automate and integrate the quotation process. Sales Cycle Index: Sales Close Index: Financial Results: Benefits: $3.1 m Costs: 2.3 m Net $0.8 m ROI 35% Payback 11 Months Baseline 6 days, Target 5 days Baseline 43%, Target 48%

Sales Effectiveness

Sales Opportunity Index Sales Close Index

Sales Cycle Index Forecast Accuracy

Sales Price Index Customer Retention Index

What Roles Within IT and the Business Can Make This Happen?
IT Roles:
- CIO - Enterprise Architect - Business Process Improvement - Project & Program Management - Business Intelligence & Data Warehousing

Business Counterparts:
- CFO - Business Strategist - Operating Committee - Business Management - Product Marketing or Financial Analyst

Let's look at the typical tasks or activity cycles for some of these roles . . .

Integrate Essential BI Competencies and Skills With a BI CC


Business Skills
Business needs
Link to business strategy Define priorities Lead organizational and process change Define BI vision Control funding BI CC BI CC Develop user skills Develop business rules Manage programs Establish standards

Organization and processes Tools and applications

Build technology blueprint

Organize methodology leadership

Analytic Skills

Identify data Have adaptable infrastructure Extract data IT Discover and explore Skills Maintain data quality

Data integration and management

Recommendations
Follow the best practices for selecting performance measures to build the foundation of your corporate performance management program. Clearly establish the relationship between the performance measures and financial outcomes so that all employees can see how operational performance drives real business value. Develop a Business Intelligence Competency Center with clearly defined roles, standards and methodologies to optimize results.