Defining the right performance targets is a matter of industry and scale

Correcting operational problems is one thing, but having better advance warning of impending problems is equally important—if not more so. Hence the interest in key performance indicators (KPI) and the obvious question: Which measurements tell me what I really need to know?

KPIs are quantifiable measurements that reflect the critical success factors of an organization. While KPIs differ depending on the organization, they always define and measure progress toward organizational goals. Paradoxically, it is likely they will manifest differently in different parts of the organization. That’s where the fun starts.

The most common KPIs are financial measures that concern profit: net profit, EBITDA, and gross margins. There are other classic examples of KPIs, including productivity, first pass yield, OEE, perfect order, and on-time delivery.

Most manufacturers rely on static metrics such as inventory levels, fixed cost measures, and average production or cycle time. These are good measures, but the problem with them, in large part, is they all look in the rearview mirror. Although these metrics certainly tell you something about your performance, they aren’t real time enough for the minute-to-minute challenges of manufacturing. Unfortunately, very few companies rely on predictive measures such as asset availability, variance analyses, or supplier-related metrics. Even fewer can correlate a measurement to its true root causes.

Links lead to strategy

Selecting the right KPIs for an organization is never easy, but certainly worth the effort. KPIs are metrics, but not all metrics are KPIs. For example, output per hour could be a KPI for some companies, while hours worked is not. So the issue for many is figuring out which measures are most meaningful.

Done well, a metrics framework will enable a manufacturer to fine-tune performance. Companies that have effective measurement environments will point to response time—i.e., the time between recognizing a problem or opportunity and taking action—as a distinct competitive advantage. The key, at the highest level, is to identify metrics that are aligned with the company’s basis of competition.

Some of these measurements are obvious: for example, revenue growth and gross margins. But the most telling metrics may not be financial. Say a company sees its reputation for fast service and high quality as the key to its success growth. Quality certainly has an impact on gross margins since better quality reduces rework costs, scrap, returns, and customer service costs. Customer satisfaction is clearly impacted by on-time delivery, so the company cannot sacrifice on time delivery for perfect quality. When a company identifies its strategic differentiators, its KPIs should reflect them.

Finding and reporting the right KPIs, responding to their messages, and refreshing them as business conditions change is a process that requires business insight, systems, data, and cultural will. It takes more than a couple of offsite meetings to figure out which KPIs to use and how to implement them. Often they are identified as part of the strategic planning process.

It may be helpful to structure your thinking about KPIs by considering four fundamental challenges.

1. Correlating key metrics;identifying root cause

Looking across functional silos and seeing the interdependencies among metrics is a challenge execs face as they wrestle with the design and implementation of next-generation KPIs. We see this type of conflict most clearly when the manufacturing organization is trying to maintain stable schedules while the distribution organization is charged with reducing inventories and increasing fill rates.

Ultimately we want to correlate operating metrics like output, quality, and employee performance to measures like customer satisfaction and market share growth. The most effective KPIs will provide aggregated measurements in the context of the company’s competitive advantage and present meaningful rollups to the board room.

The next stage is tying field performance back to materials and production activities in the plant. Companies are making it a priority to measure out-of box failures, return rates, and the cost of warranty and repairs—especially those in medical device, high-tech, and automotive.

This brings us to root cause analysis. Knowing how you scored on a specific KPI is one thing. Knowing which levers to pull to correct its course is the Holy Grail. To streamline root cause analyses and corrective actions, you must understand the KPIs and the business processes driving them.

2. Measuring critical competitive areas

Industries are continually moving ahead. This is true of metrics as well. Years ago Six Sigma performance wasn’t even a factor, yet today it is the norm in many industries. This makes it harder to think of a specific goal as being fixed: Once you get to it, it’s moved. As a result, even the method of collecting and calculating metrics needs to change.

While many like to chase down and discuss benchmarks, there are some problems—e.g., locating viable and current benchmarks, and finding ones specific enough to your competitive posture. Do you have a truly solid source of benchmarks for comparison? There also are issues to consider in defining performance targets—for example, ensuring that the ones you chose are appropriate for your industry and scale.

Metrics evolve as businesses do, and examples are emerging of several leading-edge metrics that could be important to future KPIs. As the world becomes more competitive, manufacturers need insight to a wider range of drivers and characteristics that impact how their organizations perform:

Innovation . A fresh stream of new products is essential to some companies, but most manufacturing metrics deal with steady state production, not the vagaries of prototyping, or production-line and new technology start-up challenges. This includes time-to-market and time-to-volume metrics that measure how long it takes to get a product into production, and how fast to ramp up volume to take advantage of a competitive window and higher margins.

When new products are the basis of competition, the product portfolio turnover —i.e., how much revenue comes from new products—is critical. Looking at total profits that new products generate is a key measure for the engineering and manufacturing organizations.

Agility. These measurements indicate how well an organization can manage change in relation to varied dimensions. This can include scaling production quickly, dealing with a variety of new products and configurations, integrating acquisitions and reconfiguring value chains.

Collaboration. Underpinning a manufacturer’s agility is its ability to collaborate. In today’s dispersed and complex supply networks, supply chain velocity is up, products have proliferated, and demand variability has grown. Cross-functional coordination is essential.

Companies will want to assess two factors: the organization’s culture for collaboration, and its collaboration infrastructure, including ERP and supply chain applications, Web conferencing, and instant messaging.

Complexity. Some form of complexity analysis—on both products and the processes for building them—is needed to control the effects of a growing array of configurable products and supply chains. If companies can identify the level of complexity faced by manufacturing, sourcing, and distribution, they can pinpoint actions to take to simplify operations.

3. Addressing data consistency, semantics, and latency

Nearly every manufacturer wants to enhance visibility into their far-flung manufacturing operations, and they rank multisite performance analysis as their No. 1 IT problem. Most companies, however, have an ocean of data coming from hundreds of disparate systems and databases—many of which carry the necessary data, but in different forms. This underscores the need for master data management (MDM) and data consistency across multiple databases. It also speaks to the need to understand semantics.

We may use the same words, but do they mean the same thing across a large disparate organization? Internally, our plants may use different processes and different manufacturing control systems. Suppliers may use different formulas as they calculate their version of the same measurements. There is no guarantee that data can be aggregated into one “version of the truth” even if everyone uses the same ERP vendor’s software because it’s likely each operation implemented it to optimize their own performance. These are daunting issues, especially when the supply network configuration is continually changing.

Finally, the IT organizations must develop insight into the latency of data and the metrics that managers require. Timeliness in the actual compilation and examination of data is critical, but so is the ability to respond and take action on the data.

4. Reacting to—and using—KPIs

Companies with KPI experience have institutionalized measurements, and review their KPIs regularly. These companies are not always looking to improve. They examine their metrics to ensure they are meaningful, and they aren’t afraid to jettison metrics that aren’t of value.

These companies also place high value on having the technology to collect and analyze the right information. They collect useful performance metrics in a reasonable amount of time. Most important, they have the processes in place to assess and react to the KPIs and turn information into corrective (or rewarding) actions in near-real time fashion. Reaction to last month’s poor performance isn’t viable for today’s competitors.

Savvy executives know that critical success factors won’t be achieved unless they are explicitly articulated in the goals and measures that drive an organization. They know that having a laser-like focus on what is the essence of growth and profitability is critical. Identifying KPIs that define both the result and the sources of performance is the essence of great management. But the metrics aren’t the only keys to success. Manufacturers must build the tools and instill the culture that make KPIs an insurance policy for the creation of corporate success.

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