February 18, 2020 Setting the Right Manufacturing KPIs

Identify the right KPIs to align the business operation to the overall strategy and maximize the value of your company.

For manufacturing companies, selecting the right KPIs (Key Performance Indicators) is integral to incentivize employees to think and act like owners. Whether you are trying to increase production volume, decrease unit costs or achieve overall efficiencies, KPIs can help you unlock business success by measuring what matters and aligning the behavior of the employees to achieve the organization’s goals.

After defining your company’s strategic objectives and multiyear targets, you should cascade those targets throughout the organization, making sure you consider any unintended consequences and correctly align each performance measure to one another.

Choosing the right KPIs

When identifying KPIs, finding the right balance between financial and operational KPIs is crucial to a company’s success. The first step is to “drill down” the goals for the business units and teams and define the expected contribution at each level of the organization. By having a clear understanding of the drivers that move the company’s performance, you should be able to identify what to measure and how. Remember to align the targets with the decision rights at each level of the organization to improve transparency, accountability, and incentivize the behaviors that will maximize the value of your business.

For instance, you may look to your supply chain as an area to help improve your profit margins. You decide to measure cost-per-unit as a KPI for your procurement department to encourage them to find cost savings. The purchasing team gets to work and negotiates a new deal with a key supplier – larger orders will mean lower per-unit costs. However, to get this deal, they agree to purchase enough materials to last for two years, instead of their regular order for a six-month supply.

Although they successfully lowered the cost per unit, which is the metric they were being measured on (and therefore incentivized to focus on), the company is not necessarily better off as a whole. Purchasing higher quantities of materials upfront can negatively impact cash flow, increase inventory, and pose challenges for logistics and storage.

You could have avoided this by including a combination of metrics that relate to each other and provide a full picture of how decisions contribute to the company’s performance. When you are selecting which KPIs to measure within different areas of your organization, think carefully about the potential impact on the organization as a whole.

Though each department and team should have their own KPIs, they should all derive from the organization’s overall strategy and goals. The KPIs selected should cascade from the top to bottom of the organization, providing a clear line of sight to employees of their individual goals. To achieve the organization’s goals, management needs to communicate how everyone’s work influences performance and what are the relationships between different departments.

Aligning your business KPIs

Different KPIs are commonly used across departments within a company. It is essential to understand the relationships between KPIs, given that there could be conflicting measures between them. Improving one KPI in a department may cause another KPI in a different department to deteriorate.

For instance, think of the sales and production departments. One may be interested in offering as many products as possible, while the other is focused on production efficiency (e.g., reducing the number of products or having long production runs of the same product).

If management doesn’t consider all the variables when establishing KPIs, the lack of alignment between departments may result in value destruction. In this case, you could have stock-outs of some products and high inventory levels of others – a lack of proper alignment between the demand and supply forecast. Effective KPIs align the organization and incentivize individual departments to make decisions that benefit the company, instead of trying to maximize the department’s performance.

Tracking and assessing performance

Setting the right KPIs will be meaningless unless you can track performance, provide feedback, and adapt accordingly. Ideally, you should be able to measure and communicate individual and group results timely to adjust and improve performance. The faster the company provides feedback to the employees, the more effective they will be in identifying the cause and effect of their actions, leading to better results in modifying behaviors.

To achieve this, it is essential to select metrics that you can easily track and build custom performance dashboards that show the full picture of the operation of the business and the financial implications.

Maximizing value

By understanding the value drivers of the company, the relationship between them, and how they align with the overall strategy, you will be able to set the right KPIs for the business. To maximize the value of the company, you not only need the right KPIs but also to be able to influence employees’ behavior and align them with the company strategy.

An experienced business consultant can help you achieve this alignment by assessing your business structure and process, continuously measuring and communicating the individual and company performance. This will create benefits throughout the company, impacting everything from the bottom line to developing a high-performance culture by improving transparency and accountability.

Pedro Casillo

Pedro A. Castillo is a Business Consulting Services Manager at Kaufman Rossin, one of the Top 100 CPA and advisory firms in the U.S. Pedro has worked with a wide range of clients, from micro caps to Fortune 500 companies, helping them define and implement strategies for shareholder value through performance improvement, operations improvement, target setting, capital allocation, and executive compensation. You can reach Pedro at pcastillo@kaufmanrossin.com.

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