Many business leaders have found themselves disappointed in the effectiveness of non-financial KPIs, and as a result they are often sidelined or omitted from an organisation’s practices. However, non-financial KPIs are critical to business success, and can directly influence your future financial outcomes.
Financial measures can tell us how well we have performed in the past. Our financial records can inform us of our turnover, profitability and asset value, but they cannot give us an accurate indication of future financial performance. This is where non-financial KPIs become essential.
The future success of your organisation may rely upon your ability to satisfy clients, your aptitude to innovate, and the motivation of your employees. Any changes in these factors cannot be reflected in current financial returns, but will have critical role to play in future financial performance.
The KPIs you choose to measure will often translate directly into outcomes: what you measure is what you get. Senior executives understand that KPIs can have a powerful motivating effect. For example, a sales manager who knows their performance will be judged by the total revenue that their clients bring to the company may try to see more clients than is reasonable, and in the process sacrifice the quality of their service. As a result there will be fewer returning clients, and the company’s reputation may suffer. If, on the other hand, non-financial KPIs are used, and the sales manager is aware that their performance will be partially judged on client satisfaction, then they will be far more motivated to deliver top quality service at all times. This will be in the best long-term financial interests of the company.
Research undertaken by accounting professors Christopher Ittner and David Larcker, published in the Harvard Business Review, found that from a sample pool of 157 companies, those who measured non-financial KPIs and verified that they were having an empirical effect, earned returns on equity that were about 1.5 times greater than those of companies that did not.
The issues with non-financial KPIs
Many leaders encounter serious issues in attempting to set non-financial KPIs, and as a result have lost confidence or interest in these measures. Here are some common issues encountered with non-financial KPIs:
- There is often not a direct link between the KPI and the organisation’s strategy, and therefore it can be hard to ascertain whether or not improving the non-financial KPI will steer you in the right direction
- Determining a reliable measure of a qualitative outcome is challenging, and if it is slightly misguided, you may, in fact, be measuring the wrong thing
- When bonuses are at stake, managers place greater weight on measures whose targets they know they can hit
Detailed below are some tips to help you implement effective non-financial KPIs. These measures have been designed to align and motivate people towards the organisation’s vision.
By following these steps you should be able to realise the full promise of non-financial performance measures.
- Before developing your plan, identify any obstacles that could prevent your organisation from achieving its vision. Some of the challenges encountered in the past may still be an issue. Once these obstacles have been identified, you will need to undertake a root-cause analysis. The root-causes will then need to be addressed by the strategic plan.
- Translate your strategic plan into key objectives, sub-objectives and key actions. These three tiers of your strategic plan should have clear causality links, with the key actions leading to the realisation of the sub-objectives and the sub-objectives contributing to the key objectives. The causality links will need to be regularly reviewed and assessed.
- Develop clear accountability around your plan. For each objective and sub-objective, allocate clear accountability with one owner and a team of contributors.
- For each key objective and sub-objective identify an expected result, and develop KPIs to assess the progress towards that result.
- You will then need to assess if the measurement process is accurately determining whether or not the action plans have succeeded in producing desired results. It is also important to check whether improvement in one area may have come at the expense of another.
- Finally, you need to act upon your results. Disappointing financial measures sometimes occur because companies don’t follow up their operational improvements with another round of actions. Quality and cycle-time improvements can create excess capacity.