Today we won’t talk about strategy, objectives and improving ultimate business performance. Questions that I receive often indicate that sometimes it worth returning back to the basics. Today, I suggest you pass a “Scorecard and KPI 101″ course. “101” normally means an introductory level of learning, in our case it might be a little bit more advanced, as I assume that my readers already have some developed background in the field of business scorecards and KPIs.
KPIs, indicators, metrics
From the business viewpoint it doesn’t make sense to call something “KPI” until a business context is defined. Still, in this article I’ll be using the “KPI” term as it is more popularized. The better idea would be to avoid the “KPI” term and use just “metric” or “indicator” instead. These aspects were discussed in details in a previous article.
What problems are KPIs and a scorecard supposed to solve?
Indicators are numerical values that are linked to some kind of process. In simple words, their primary goal is to show a number that can give us an idea about the current performance of the process. We can group these indicators and calculate their aggregated values, and in this case we are talking about a scorecard.
Here is the list of the areas where an indicator and a scorecard can be applied.
On indicator level:
- Show the current value of an indicator.
- Introduce the performance function of an indicator, e.g. higher value means higher performance or higher value means lower performance.
- Interpret the value of an indicator on a baseline/target scale, e.g. calculate the progress in improving the value of the indicator.
On scorecard level:
- Group indicators into categories. Specify the relevant importance of the indicator compared to other indicators.
- Calculate the performance of category and the total performance by taking in an account the performance values and weights of the indicators.
Let’s review these ideas from basics to the calculation of the total performance index.
The value of an indicator
Let’s start with simple examples of indicators’ values:
- 530 $ – “530” is a numeric value and “$” is a measure unit.
- 20 hours/week – “20” is a numeric value and “hours/week” is a measurement unit.
What if an indicator doesn’t have a numeric value, but we still want to use it? For example: when we deal with an expert opinion, one needs to come up with a way to quantify it. Instead of answering a question, the expert is supposed to choose one of the options associated with a numeric value.
The role of the performance function
There is one important idea in the previous paragraph: each indicator has its own measurement units. On the scorecard we cannot deal directly with incomparable measurement units like “$” and “hours/week.” But we can come up with a mathematical function that will put various indicators on the same scale. I’m talking about the performance function for an indicator.
What actually the value “530$” means? Is it a high value or low value? We cannot answer these questions until we have a measurement scale. Let’s create it:
- Min – means the minimal possible value of an indicator
- Max – means the maximal possible value of an indicator
- If min=$0 and max=$600 then we can say that an indicator with the value $530 actually tells us that we are doing well!
The performance of an indicator can be calculated as:
- Performance (Value), % = ((Value – Min) / (Max – Min)) * 100%
In our example the performance will be (530 – 0) / (600-0) = 88%
The performance function is not always linear
The formula that was introduced above is a linear function. It means that with a linear growth of the “value” the performance will also grow linearly. This is the most frequent case for a performance function, but there might be other performance functions as well.
For example, the performance might grow very slowly in the beginning, but then increase rapidly. The performance function in this case might be something like this:
- Performance (Value), % = Power(Value,10) / Power(Max, 10)
Before we were talking only about the performance that grows with the increase of the value, but it might be decreasing as well. For example, the more waiting time there is in the support center, the lower is its performance. In this case the linear performance function will look like this:
- Performance (Value), % = ((Max – Value) / (Max – Min)) * 100%
This might sound a little bit complicated to do if you use MS Excel or similar software, but a professional scorecard software, like BSC Designer will automate these tasks for you.
Calculating the progress
Sometimes it is necessary to focus attention on a very specific part of the performance interval, which is important for the current business task.
For example, the support center of a company uses an “Average email response time” indicator. The Min can be 0, and the Max can be 72 hours. Currently, a company answers most questions within 48 hours. According to these numbers the company performance is on a good level.
Let’s continue with a case: according to the information from the latest studies, “queries from online prospects that were answered within an hour were seven times more likely to generate a qualified lead.” Managers decided to decrease average email response time. For their planning horizon they have a starting point (baseline), which is 48 hours, and they have a destination point (target) which is 1 hour. But the performance function doesn’t take these values into account.
For this purpose one could introduce a progress function, which will be very similar to the performance. The new function actually will use the same mathematical function as it was used for the performance function, but it will use it on a different scale. Compare:
- Performance (Value), % = ((Max – Value) / (Max – Min)) * 100%
- Progress (Value), % = ((Value – Baseline) / (Target – Baseline)) * 100%
Both functions indicate that the performance will increase with the decrease of the response time. What will happen to the performance and progress when a company has a response time equal to 38 hours? Let’s calculate:
- Performance (38 hours), % = ((72 – 38) / (72 – 0)) * 100% = 47%
- Progress (38 hours), % = ((38 – 48) / (1 – 48)) * 100% = 21%
As you can see we need both: performance and progress functions, as they actually tell us a different story about an evaluation process:
- “Min” and “Max” are used to calculate the performance of the KPI. The performance answers the question: “What is the overall success according to the KPI?”
- “Baseline” and “Target” are used to calculate the progress. The progress answers the question: “To what extent was the target achieved?”
If you will calculate the performance and the progress for the value= 1 hour (specified target was achieved), then for the progress it will be 100% (we need to define this point manually to avoid division by zero) and the performance will be 98%.
In terms of the “performance” there is a space for a further 2% improvement, but in terms of the “progress” that reflect a business sense, the target was achieved.
Scorecard level. Weight – the relevant importance of KPIs
Another challenge that was mentioned above is that we need to specify the relevant importance of a KPI in some way. For example, a support center has two KPIs:
- “Average email response time,” hours
- “First contact resolution rate,” %
A company can make “Average email response time” equal to 10 minutes, but this will not make customers happy, as the “First contact resolution rate” will be very low. Good response time is important, but what is more important is the high quality of the answers. To reflect this idea we need to introduce a concept of “weight” to the indicator.
- “Average email response time,” hours; weight = 4
- “First contact resolution rate,” %; weight = 6
Now we know that “First contact resolution rate” is more important than “Average email response time.” To simplify future calculations we will define weight on the scale from 1 to 10 and we will require that the sum of all weights has to be 10.
Learn more about the business application of the “weight” idea.
If you use some software like BSC Designer for your business scorecard then most likely it will suggest more flexible settings for the weight and you will avoid unnecessary math exercises.
Calculating the total performance
We know the performance of each indicator in the scorecard. Also, we know the relevant importance (the weight) of each indicator compared to the relevant importance of other indicators in the category.
- The performance of a category can be calculated by taking in account the performance values of each indicator and their weights.
In the same way the total performance of the scorecard can be calculated. It will incorporate the performance of all indicators taking into account their relevant weights and the relevant weights of their categories.
The business meaning of the “total index”
Below you will find formulas that help to do all of these calculations. Before talking about mathematics, I’d like to discuss the business sense of calculating this total performance value.
Actually it is still disputable. Some say that they need to have “a number” that is supposed to reflect the current performance of the company. An opposite argument is that this aggregated index will be too complex to possibly give any meaningful information.
It might be hard to find the business meaning of the total scorecard index, but for sure, it makes sense to calculate the performance of specific categories. As in an example above, the performance level of the “Customer support” category has two weighted indicators: “Average email response time” and “First contact resolution rate” that will actually show if customer support does a good job balancing responses’ quality and response time.
How the scorecard performance is calculated
Now, let me show the math that stands behind the calculation of the total performance.
Here we have the structure of the scorecard where C1..4 – are categories. Metric-i,j are our indicators together with their weight and performance values:
Let’s convert this into a different notation:
We had our weight on a scale 1..10, so before moving ahead we need to calculate a normalized weight:
The total performance value for the selected category is be calculated as:
Where Ni is the number of metrics on i-level; NWi,j – is a normalized weight of j-metric on i-level; NSi,j – is a performance of j-metric on i-level.
To calculate the total performance within all categories, it’s necessary to summarize performance values for all levels:
Where M is a number of categories. The final formula for the total performance index of the scorecard will be:
These calculations are simple if you don’t have subcategories in your scorecard. If you had subcategories, the weight of these subcategories should be taken into account in a similar way. Professional scorecard software like BSC Designer will automate these calculations so that you can focus on the business side.
Examples of the scorecard in MS Excel
Here is an example of business scorecard in Excel. The calculations there work as described in this article. The general problem with scorecards in Excel is that when your project gets updated; it will be hard to maintain a spreadsheet. Check out an article on this topic if you are interested in the details.
What is your experience with scorecards? Do you think it is only good as an academic exercise? What tasks does a scorecard help to solve in your business?