The One Huge Mistake Companies Make When Monitoring Business Performance
You’ve been tracking the wrong business metrics the whole time.
Don’t worry. It’s not as much about the indicators you monitor but the reasons why you do it and the theories on which your strategy lies.
According to behavioral economics expert and psychologist Daniel Kahneman, we’re inclined to adjust our analysis to support the facts that we already know. This applies to journalism, making reporters stress the facts that their audience already believes. The same bias also dominates in business.
What managers tend to do, is pick business KPIs that are the easiest to measure – the most obvious ones – and position these as the indicators of overall success.
That’s why leaders tend to monitor disproportionately many financial KPIs compared to other non-material KPIs. They’re the easiest to measure and show indubitable numbers, reflecting on growth in revenue and profits.
You’re neglecting the most important metrics
The mistake so many leaders make is to ignore all of the smaller contributing factors that affect the attainment of business goals.
Let’s say there’s a new startup that provides home delivery for groceries. As a starting company, it is natural for them to measure new customer acquisition rate and revenue growth. But these numbers should be taken with a pinch of salt, as they’re not really telling us anything. Whether there’s growth or decline in monthly revenue, we have no idea of the factors behind these results.
We tend to make guesses about the cause of change, but we’re unable to distinguish between knowing facts from observation and what we guess is a fact.
Why non-material factors matter
While financial indicators benefit us on the macro level, we need to dig deeper to understand the cause and effect of persistent events. Keep in mind the word persistent as you need to monitor the change persistently to be able to identify whether a change was due to your actions or pure luck.
Financial metrics indicate the continuous growth or decline of a company’s growth. To grasp the full potential of performance monitoring, these material KPIs need to be complemented with measures that help us understand the reasons behind the numbers. For example, growth in sales is affected by product quality, customer happiness, employee satisfaction, etc.
The disturbing fact is that according to a 2003 study, only 23% of companies had developed an extensive causal modelling strategy to understand the reasons behind the effects they were measuring. Yet according to the study, those 23% had 2.94% higher ROA and 5.14% higher ROE than companies that didn’t use causal models.
“Companies that had developed a causal modelling strategy had 2.94% higher ROA and 5.14% higher ROE than companies that didn’t use causal models.”
According to the authors of the study, the major challenge for companies lies in determining which non-financial measures to track.
How to define effectual business performance metrics:
In 2016, Netflix debuted in 130 new countries. The company has a 75 million user base, but it wouldn’t have reached the numbers if it wasn’t for it’s data-driven business model. “There’s a mountain of data that we have at our disposal,” Todd Yellin, Netflix’s VP of product innovation has claimed. And the company knows what factors contribute to its growth in every single country because it has developed a thorough strategy to truly grasp its data.
You can build a similar strategy as well. The core essence of a causal model is to perceive the links between multiple factors that have an effect on long-term economic performance. The first step is to define one principal goal and start monitoring all the related business KPIs that have an effect on its performance.
1. Determine your chief goal
No matter how many KPIs you’re currently monitoring, the first step is to develop a clear business strategy with one chief measurable goal. This main objective will guide the allocation of time and resources while being the Holy Grail of long-term business growth.
For most of the companies, the main goal is to create economic value and grow month over month. However, the principal objective can also be related to product quality, customer acquisition, etc. Whichever the chief goal, it needs to rule over all other performance metrics and be the principal indicator of your company’s success.
In the absence of a well-defined business goal, managers have a hard time on agreeing on the measurements of success. Moreover, a company that lacks a concrete vision is apt to allocate its resources inefficiently and return a lower profit.
Setting a primary goal is paramount to establishing the core values and effective resource allocation inside a company.
2. Develop a causal model
What actually drives your company’s growth?
Hint: it’s not your monthly recurring revenue or the number of new customers. While these two metrics are a great indicator when tracking a company’s growth, they’re not the answer to why the company expands. Naturally, macro-level metrics such as the profit margin can’t capture all value-creating activities.
According to professors Christopher D. Ittner and David F. Larcker, “The first step is to develop a causal model based on the hypotheses in the strategic plan. Unfortunately, however, many companies’ strategic plans are more like mission or vision statements than road maps.”
To develop a causal model, managers need to found their hypotheses on the company’s chief goal. To find what actually affects the company’s growth, you need to tap into creativity and think of all the possible elements that contribute to growth indicators displayed on your KPI dashboard.
Think of your company as a huge web where every component is interrelated to others: New hires, education, work experience, employee satisfaction, employee-added value, customer satisfaction, sustained profitability, shareholder value, etc.
Look further than easily accessible financial KPIs and truly apprehend the non-material drivers of your chief goal. To do that, you need to lean against your cognitive biases and think what you need to know, instead of what you already know.
Build a cause-and-effect theory about which factors affect your economic performance, and make a list of all the interrelated business KPIs that contribute to your main goal. If you’d like, draw your causal model on a piece of paper or create an illustration, to truly grasp the links between each element.
3. Collect relevant data
To establish a causal model for tracking your company’s performance, you’re going to need lots of relevant and consistent data.
According to Ittner and Larcker, “Most companies already track large numbers of nonfinancial measures in their day-to-day operations. So to avoid going to the trouble of collecting data that already exist, companies should take careful inventory of all their databases.”
“To avoid going to the trouble of collecting data that already exist, companies should take careful inventory of all their databases.”
Don’t neglect some relevant KPIs just because you lack the data to measure them. Instead, develop a company-wide model for measuring more complex performance indicators.
Always be consistent in your performance measurement strategy. To be able to interpret the effect of various factors to your overall objectives, you need to monitor the KPIs consistently, following the same formula month over month. The best way to do it is to set up a business dashboard that helps you keep track of all relevant numbers.
4. Keep the power to influence your performance
Imagine the value of your performance metrics is displayed on a scale with a needle. How can you influence the needle to move towards your anticipated result, say from left to right?
Specify the activities that contribute to the changes in your performance measurements. If one of your objectives is customer satisfaction, see how you can increase its performance through your actions. Can you improve the quality of your product, change the packaging, advance customer service, etc.?
Outline your entire team’s skill set and see how each employee can contribute to improving one or two KPIs. Next, develop a clear plan to achieving the primary objective through your actions, and establish a resource allocation plan that supports the chief goal.
5. Review regularly
As your business grows, the goals along with success indicators tend to change.
Constantly reassess your business metrics and see whether they continually endorse your main objectives.
Test, test, and test. No KPI measurement plan is perfect – there are always fragments left unnoticed. Incessantly search for new elements in your success equation and apply these to your KPI strategy.
Be creative and innovative about the cause and effect theory of achieving your ultimate goals and look for new ways to improve the outcome of your work.
Nobody can afford to track the wrong performance metrics. Take time to reevaluate your business statistics and ensure that they’re founded on a cause-effect model, giving insight to all contributing factors of achieving your long-term business goals.
Put this knowledge into action. Read on: The Business Metrics Every Company Should Know, and find out how to measure and improve them.
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