A growing business needs to be closely and carefully managed to ensure the success of new investment decisions and expansion plans. However, many owner-managers find that as their business grows they feel more remote from its operations.
Putting performance measurement systems in place can be an important way of keeping track on the progress of your business. It gives you vital information about what's happening now and it also provides the starting point for a system of target-setting that will help you implement your strategies for growth.
This guide sets out the business benefits of performance measurement and target-setting. It shows you how to choose which key performance indicators (KPIs) to measure and suggests examples in a number of key business areas. It also highlights the main points to bear in mind when setting targets for your business.
The importance of measurement and target-setting
Performance measurement and target-setting are important to the growth process. While many small businesses can run themselves quite comfortably without much formal measurement or target-setting, for growing businesses the control these processes offer can be indispensable.
The benefits of performance measurement
Knowing how the different areas of your business are performing is valuable information in its own right, but a good measurement system will also let you examine the triggers for any changes in performance. This puts you in a better position to manage your performance proactively.
One of the key challenges with performance management is selecting what to measure. The priority here is to focus on quantifiable factors that are clearly linked to the drivers of success in your business and your sector. These are known as key performance indicators (KPIs). See the page in this guide on deciding what to measure.
Bear in mind that quantifiable isn't the same as financial. While financial measures of performance are among the most widely used by businesses, nonfinancial measures can be just as important.
For example, if your business succeeds or fails on the quality of its customer service, then that's what you need to measure - through, for example, the number of complaints received. For more information about financial measurement, see the page in this guide on measurement of your financial performance.
The benefits of target-setting
If you've identified the key areas that drive your business performance and found a way to measure them, then a natural next step is to start setting performance targets to give everyone in your business a clear sense of what they should be aiming for.
Strategic visions can be difficult to communicate, but by breaking your top level objectives down into smaller concrete targets you'll make it easier to manage the process of delivering them. In this way, targets form a crucial link between strategy and day-to-day operations.
Deciding what to measure
Getting your performance measurement right involves identifying the areas of your business it makes most sense to focus on and then deciding how best to measure your performance in those areas.
Focusing on key business drivers
Your performance measurement will be a more powerful management tool if you focus on those areas that determine your overall business success.
This will vary from sector to sector and from business to business. So put some time into developing a strategic awareness of what it is that drives success for businesses like yours.
It's crucial that you tailor your measurement to your specific circumstances and objectives. A manufacturer producing and selling low-cost goods in high volume might focus on production line speed, while another producing smaller quantities using high-cost components might focus instead on reducing production line errors that result in defective units.
Finding your specific measures
Once you have identified your key business drivers, you need to find the best way of measuring them. Again, your priority here should be to look for as close a link as possible with those elements of your performance that determine your success.
For example, you may decide that customer service is a strategic priority for your business and to therefore start measuring this. But there are many ways of doing so.
You might consider measuring:
- the proportion of sales accounted for by returning customers
- the number of customer complaints received
- the number of items returned to you
- the time it takes to fulfil an order
- the percentage of incoming calls answered within 30 seconds
None of these is necessarily better than any other. The challenge is to find which specific measure (or measures) will enable you to improve your business.
This type of measurement unit is often referred to as a key performance indicator (KPI). The two key attributes of a KPI are quantifiability (i.e. you must be able to reduce it to a number) and that it directly captures a key business driver. See the page in this guide on choosing and using key performance indicators.
Using standardised measures
There are standardised performance measures that have been created which almost any business can use. Examples include balanced scorecards, ISO standards and industry dashboards.
Choosing and using key performance indicators
Key performance indicators (KPIs) are at the heart of any system of performance measurement and target-setting. When properly used, they are one of the most powerful management tools available to growing businesses.
There are a number of key criteria that your KPIs should meet:
- First, they should be as closely linked as possible to the top-level goals for your business. See the page in this guide on deciding what to measure.
- Second, your KPIs need to be quantifiable. If you can't easily reduce your measurement to a number, there will be too much scope for variation and inconsistency if different people carry out the measurements at different times.
- Third, your KPIs should relate to aspects of the business environment over which you have some control. For example, interest rates may be a crucial determinant of performance for a given business, but you can't use the Bank of Canada base rate as a KPI because it's not something that businesses have any power to change. By contrast, a business' exposure to fluctuations in interest rates can be controlled and so this might make a useful KPI.
Getting the most from your KPIs
The purpose of performance measurement is ultimately to drive future improvements in performance. There are two main ways you can use KPIs to achieve this kind of management power.
The first is to use your KPIs to spot potential problems or opportunities. Remember, your KPIs tell you what's going on in the areas that determine your business performance. If the trends are moving in the wrong direction, you know you have problems to solve. Similarly, if the trends move consistently in your favour, you may have greater scope for growth than you had previously forecast.
The second is to use your KPIs to set targets for departments and employees throughout your business that will deliver your strategic goals. For more information about using target-setting to implement your strategic plans, see the page in this guide on how to set useful targets for your business.
Managing your information
As with most areas of your business operations, the more detailed and well structured the information you keep about your KPIs is, the easier it will be to use as a management tool. Computer-based management information systems are available for this purpose.
Measurement of your financial performance
Getting on top of financial measures of your performance is an important part of running a growing business.
It will be much easier to invest and manage for growth if you understand how to drill into your management accounts to find out what's working for your business and to identify possible opportunities for future expansion.
Measuring your profitability
Most growing businesses ultimately target increased profits, so it's important to know how to measure profitability. The key standard measures are:
- Gross profit margin - this measures how much money is made after direct costs of sales have been taken into account, or the contribution as it is also known.
- Operating margin - the operating margin lies between the gross and net (see below) measures of profitability. Overheads are taken into account, but interest and tax payments are not. For this reason, it is also known as the EBIT (earnings before interest and taxes) margin.
- Net profit margin - this is a much narrower measure of profits, as it takes all costs into account, not just direct ones. So all overheads, as well as interest and tax payments, are included in the profit calculation.
- Return on capital employed (ROCE) - this calculates net profit as a percentage of the total capital employed in a business. This allows you to see how well the money invested in your business is performing compared to other investments you could make with it, like putting it in the bank.
Other key accounting ratios
There are a number of other commonly used accounting ratios that provide useful measures of business performance. These include:
- liquidity ratios, which tell you about your ability to meet your short-term financial obligations
- efficiency ratios, which tell you how well you are using your business assets
- financial leverage or gearing ratios, which tell you how sustainable your exposure to long-term debt is
Bear in mind that even though you are likely to use an increasing number of financial measures as your business grows, one of the most familiar – cash flow - remains of fundamental importance.
Cash flow can be a particular concern for growing businesses, as the process of expansion can burn up financial resources more quickly than profits are able to replace them.
Measurement and your customers
Finding and retaining customers is a crucial task for every business. So when looking for areas of your business to start measuring and analysing, it's worth asking yourself if you know as much as possible about your clientele.
See your business through your customers' eyes
Looking at things from your customers' perspective can help you avoid getting sidetracked as you consider your options for growth.
Feedback is key - the more you know about what your customers think and want, the easier it will be to cater for growing numbers of them. Look for as many ways of capturing this information as possible, including:
- sales data - what your customers choose to buy (or not to buy) provides the clearest indication of their preferences
- complaints - but remember that many customers will simply switch suppliers before making a complaint
- questionnaires and comment cards - a very useful source of information, so consider using incentives to encourage more customers to complete them
- mystery shopping - having someone pose as a customer for research purposes can give a very clear sense of how well you are performing
Manage customer information and relationships
Software for customer relationship management (CRM) can be a powerful tool for capturing and analysing information about your customers and the products and services they purchase.
CRM also enables you to push up service levels by ensuring that all customer-facing staff have ready access to each customer's history.
Widen your focus beyond current customers
Selling more to existing customers might be the easiest way of increasing sales, but most businesses aiming for significant growth will need to find ways of reaching new groups of customers.
So knowing more about sections of the market you haven't yet tapped is crucial.
Measurement and your employees
As your business grows the number of people you employ is likely to increase. To keep on top of how your staff are doing, you may need to find slightly more formal ways of measuring their performance.
Measuring through meetings and appraisals
Informal meetings and more formal appraisals provide a very practical and direct way of monitoring and encouraging the progress of individual employees. They allow frank exchanges of views by both sides and they can also be used to drive up productivity and performance through setting employee targets and measuring progress towards achieving them.
Regular staff meetings can also be a very useful way of keeping tabs on wider developments across your business. These meetings often give an early indicator of important concerns or developments that might otherwise take some time to come to the attention of your management team.
Quantitative measurement of employee performance
Looking at employee performance from a financial perspective can be a very valuable management tool. At the level of reporting for the overall business, the most commonly-used measures are sales per employee, contribution per employee and profit per employee. These measures shouldn't be thought of as an alternative to the broader appraisals outlined above, but can flag up issues that might later be explored in more detail in those meetings.
Expressing employee performance quantitatively is easier for some sectors and for some types of worker. For example, it should be quite easy to see what kind of sales an individual sales person has generated, or how many units manufacturing employees produce per hour at work.
But with a bit more effort, these kinds of measures can be applied in almost any business or sector. For example, using timesheets to assess how many hours an employee devotes each month to different projects or customers under their responsibility gives you a way of assessing what the most profitable use of their time is.
Measurement against other businesses - benchmarking
Benchmarking is a valuable way of improving your understanding of your business performance and potential by making comparisons with other businesses.
Who to benchmark against
It is usually helpful to compare yourself against businesses in the same sector. But your market position and your objectives, among other things, will affect the specific comparisons you want to make.
For example, a small business in a crowded sector may want to benchmark itself against average performance levels in the sector. But a business targeting rapid and significant growth may choose comparisons with an established market leader.
You can also benchmark internally within your business. For example, comparing absenteeism rates between departments may enable you to spread good working practices from the best-performing areas of your business.
What to benchmark
In general, the same rule applies to benchmarking as to choosing which performance measures to use. You should focus on those areas that drive business success in your sector - your key drivers. See the page in this guide on deciding what to measure.
How to benchmark
You should have ready access to all the figures for your own business, so the main challenge with benchmarking is often the process of finding external data for your comparisons.
There are a number of sources for this kind of information:
- Your trade association is a useful starting point, as these organisations often collate sector-wide statistics.
- Commercial market reports may provide greater detail, although these can be costly.
Using your benchmarking data
Benchmarking data should be used in the same way as any other performance measurement data you generate - as a spur to improve the way your business operates.
Typically this will involve setting targets to help you reach the benchmark values you aspire to. For more information on target-setting, see the page in this guide on how to set useful targets for your business.
Measurement in the manufacturing sector
The manufacturing sector is one in which there is significant scope for performance measurement, as most aspects of the production process can be accurately measured in quantitative terms.
An indication of the way manufacturers can measure their performance is provided by the Quality-Cost-Delivery (QCD) system. This comprises seven key measures which between them capture some of the key drivers of most manufacturing operations.
The seven QCD measures are:
- Not right first time (NRFT) - this is a measure of the rate of defective units being produced. The higher it goes, the greater the waste of resources and the greater the risk that customers will be inconvenienced.
- Stock turns (ST) - this gauges the number of times a business sells and replaces its inventory. Higher stock turn rates indicate that a business is operating efficiently and not tying up resources in slow-moving inventory.
- Overall equipment effectiveness (OEE) - this is a way of measuring whether you're making the most of a piece of machinery. It combines three elements - the amount of time the machine can be used, the rate at which it is operated and the proportion of its output that is defective.
- People productivity (PP) - this measures the number of worker hours taken to produce each unit of output. However, PP also distinguishes between valuable and wasteful production - this to ensure that productivity figures aren't skewed by the overproduction of units for which there's no customer demand.
- Floor space utilisation (FSU) - this measures the level of revenue generated per square metre of factory floor space. It reflects how efficient a business is at minimising its fixed costs.
- Delivery schedule achievement (DSA) - this measures your success at delivering the goods your customers have ordered to the schedule you have promised them.
- Value added per person (VAPP) - this measures the amount of value the manufacturing process adds to raw materials and compares it to the number of people involved in the process. Like PP above, it is a measure of employee productivity.
How to set useful targets for your business
It is just a small step from measuring your performance to the much more dynamic process of driving up performance levels across your business. This involves setting performance targets in the key areas that drive your business performance.
For more information about these business drivers, see the page in this guide on deciding what to measure.
Key performance indicators (KPIs), targets and business strategy
Performance targets are a powerful management tool that can help you deliver the kind of strategic changes that many growing businesses need to make. The top-level objectives of your strategic plan can be implemented through departmental goals, and setting targets based on KPIs is an ideal way of doing this.
For example, a company seeking to expand on the basis of its product design capabilities might target year-on-year increases in the number of patents it secures, of new products it launches, or of its licensing income. The specifics will depend on which KPIs best capture the dynamics in the market.
Setting SMART targets
It's a familiar acronym, but a very useful one - your targets should be SMART - specific, measurable, achievable, realistic and time-bound:
- Using KPIs ensures your targets will meet the first two criteria, as all KPIs should, by definition, be specific and measurable. For more information about KPIs, see the page in this guide on choosing and using key performance indicators.
- Achievable - you need to set ambitious targets that will motivate and inspire your employees, but if you set the bar too high you risk deflating and discouraging them instead. Look back at your performance data for recent years to get a sense of what kind of performance boosts you've seen before - this will give you a sense of what is feasible.
- Realistic - setting realistic targets means being fair on the people who will have to reach them. Make sure you only ask for performance improvements in areas that your staff can actually influence.
- Time-bound - people's progress towards a goal will be more rapid if they have a clear sense of the deadlines against which their progress will be assessed.
Assigning responsibility and resources
Once you have identified the targets based on your KPIs that you believe will deliver the strategic growth you're aiming for, make sure you follow through by assigning clear responsibility for delivering each of them.
It is fine for your top-level strategic objectives to be abstract and business-wide, but your KPI targets should be concrete and clearly owned by a department or individual.
Hitting your targets is unlikely to be a cost-free process, so be ready to make the necessary resources available when needed. Also, undertake regular reviews to assist with motivation and to make changes if the progress made isn't as expected.
Original document, Measure performance and set targets, © Crown copyright 2009
Source: Business Link UK (now GOV.UK/Business)
Adapted for Québec by Info entrepreneurs