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What Is A 'Key Performance Indicator (KPI)'?

Not all Measurements are equally important. Measurements of the critical parts of a system are called Key Performance Indicators (KPIs), and paying attention to critical measurements can help you improve your business system.

Anything that’s not directly related to a core business process or a system’s throughput is probably not a KPI.

Josh Kaufman Explains 'Key Performance Indicators'

Here’s the primary problem with Measurement: you can measure a million different things. Measure too much, and you’ll inevitably suffer from Cognitive Scope Limitation, drowning in a sea of meaningless data.

Some measurements are more important than others: Key Performance Indicators (KPIs) are measurements of the critical parts of a system. Measurements that don’t help you make improvements to your system are worse than worthless: they’re a waste of your limited attention and energy. If your intent is to improve the system you’re examining, you don’t have to pay attention to everything—just a few key measurement that actually matter.

Unfortunately, it’s very easy to fixate on things that are easy to measure instead of things that are actually important. Take, for example, a business’s revenue — seems pretty important, right? It is, but only to a point: revenue is important only because it’s a key component of profit. It doesn’t matter if you collected $1,000,000 in revenue if you spend $2,000,000 to collect it.

As Theo Paphitis, a serial entrepreneur and host of the hit BBC series “Dragon’s Den,” memorably put it: “Profit is sanity. Turnover is vanity.” Alone, revenue is not a KPI.

The same thing goes for other in-process measurements. For example, if you’re managing a team of programmers, it’s tempting to measure their output in “lines of code” – a visible, easy-to-collect measure. Here’s the problem: more code is not necessarily better. A talented programmer can make a program better by rewriting it using fewer lines of code. If you fixate on quantity, removing 10,000 lines looks like a setback, even if it’s actually a huge improvement.

The situation gets even worse if you reward programmers on lines of code: Incentive-Caused Bias will ensure that your code looks like the programming equivalent of War and Peace.

Typically, business-related KPIs are either directly related to the 5 Core Business Processes or Throughput. Here are a few questions I use to identify a business’s KPIs:

1. Value-Creation: how quickly is the system creating value? What is the current level of inflows?
2. Marketing: how many people are paying attention to your offer? How many prospects are giving you permission to provide more information?
3. Sales: how many prospects are becoming paying customers? What is the average customer’s Lifetime Value?
4. Value-Delivery: how quickly can you serve each customer? What is your returns or complaints rate?
5. Finance: what is your profit margin? How much purchasing power do you have? Are you financially sufficient?

Any measurements directly related to these questions are probably KPIs. Anything that’s not directly related to a core business process or a system’s throughput is probably not.

Try to limit yourself to only 3-5 KPIs per system. When collecting measurements, it’s tempting to build yourself a “dashboard” that contains every piece of information you’d ever want to see. Resist the temptation: if you overload yourself with too much data, you’ll be far less likely to see changes that are critically important. You can always dig deeper into the data at your disposal if necessary.

Find your system’s KPIs, and you’ll be able to manage your system without drowning in data.

Questions About 'Key Performance Indicators (KPIs)'

• What are the key components of the system you're analyzing? How can you measure them?
• Of those measurements, what is the set of 3-5 KPIs that will give you the most important information you need to know about how the system is operating?

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"It is better to have an approximate answer to the right question than an exact answer to the wrong question."

John Tukey, statistician

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