Unit 4 · Topic 4.2 · about 30 minutes
Evaluating Performance Using KPIs
Choose KPIs that fit a business's goals, calculate and read them, and compare them with internal or external benchmarks to judge how the business is performing.
Predict first
Two bakeries each delivered 91% of their wholesale orders on time last month. Bakery A measures itself against an industry standard of 85%. Bakery B delivered 97% of its orders on time, on average, last year. Which bakery's 91% is the warning sign?
What a KPI is
A key performance indicator (KPI) is a data point used to measure a business's performance, including its progress toward short-term and long-term goals and the effectiveness of its strategy. If a courier service's strategy is to win clients by being more reliable than its rivals, the percentage of deliveries received on time tells it whether the strategy is working.
No business tracks everything. Managers select KPIs that relate to the business's stated mission and goals, its profitability, and its ability to stay competitive and viable over the long term. That is why KPIs vary with the business and the industry it operates in. A gym cares a great deal about how many members renew each year. A software company that sells subscriptions watches what it spends to win each new customer.
A KPI is a measurement, so it names something you can count or calculate: "percentage of deliveries received on time", not "deliver faster". Whether the number is good or bad comes later, when you compare it with a benchmark.
KPIs for financial health
Businesses monitor their financial health with KPIs such as revenue, COGS, gross profit, gross profit margin, operating expenses, operating profit, operating profit margin and cash flow. Most of these come straight off the income statement, which you built line by line in 3.6 The Income Statement. The two margins turn profit into a share of revenue, so you can compare one year with another, or a small business with a large one.
Cash flow, the difference between the cash coming in and the cash going out, belongs on the list because profit and cash are not the same thing. A business can show a profit for the year and still be unable to pay its suppliers next week.
| KPI | Goal area | What it measures |
|---|---|---|
| Customer acquisition cost | Marketing and sales | Total marketing, advertising and sales costs of winning new customers, divided by the number of new customers |
| Customer lifetime value | Marketing and sales | The estimated amount a customer will spend on the business's products over time |
| Customer satisfaction ratings | Marketing and sales | How customers rate their experience, such as an average of 4.6 out of 5 stars |
| Customer retention data | Marketing and sales | How many customers keep buying, such as the share of last year's members who renewed |
| Total sales | Marketing and sales | How much the business sold during a period |
| Market share | Marketing and sales | The business's share of all the sales in its market |
| Per-unit cost | Operations | What it costs to produce each unit |
| Delivery cost | Operations | What it costs to get orders to customers |
| Order accuracy | Operations | How often customers receive exactly what they ordered |
| Percentage of deliveries received on time | Operations | The share of all deliveries that arrive when promised |
Some KPIs say more side by side than alone. If a business spends more to win a customer than that customer will ever spend with it, every new customer loses money, however good total sales look. That is why managers read customer acquisition cost and customer lifetime value together.
Sort it
A KPI is a data point you can measure. Tap each card, then tap whether it is a KPI or a goal that still needs one.
KPI
Goal, not a KPI
Worked exampleChecking three KPIs against their benchmarks
Trailhead Outfitters sells camping gear online. Here are its numbers for the spring quarter.
- Revenue: $480,000
- COGS: $264,000
- Marketing, advertising and sales costs of winning new customers: $54,000
- New customers: 1,800
- Orders delivered: 6,120, of which 5,814 arrived on time
Its benchmarks are last spring's gross profit margin of 48.0%, last spring's customer acquisition cost of $36, and an industry standard of 92% for on-time deliveries. Calculate each KPI, compare it with its benchmark, and say which part of the business needs attention.
Gross profit margin. Gross profit is 480,000 minus 264,000, which is $216,000, and 216,000 divided by revenue of 480,000 is 45.0%. That is 3 points below last spring's 48.0%.
Customer acquisition cost. 54,000 divided by 1,800 new customers is $30 per customer. Compared with last spring's benchmark, that is a percent change of (30 minus 36) divided by 36, times 100, a decrease of about 16.7%. Each new customer cost about a sixth less to win.
On-time deliveries. 5,814 divided by 6,120 is 95.0%, 3 points above the industry standard of 92%.
Interpret. Marketing is winning customers more cheaply than a year ago, and deliveries beat the industry. The weak spot is the gross profit margin. A falling gross margin points to pricing or to direct costs, so the next question is whether suppliers raised their prices or the store discounted too much.
The gross profit margin needs attention: 45.0% against a benchmark of 48.0%. Customer acquisition cost and on-time deliveries both beat their benchmarks.
Benchmarks
A benchmark is a reference point used to compare data to a standard. Businesses may base their benchmarks on either of two sources:
- Internal historical data: the business's own past results, like Bakery B's 97% from last year.
- External industry standards: typical results for businesses in the same industry, like the 85% that Bakery A uses.
Businesses compare KPI data with the benchmarks they select to see how they are performing against a known standard. The two kinds answer different questions. An internal benchmark tells you whether the business is getting better or worse. An external one tells you how it compares with businesses like it. A KPI can look good against one and bad against the other, so a careful manager checks both.
Check your understanding
A bike-share company's goal this year is to keep more of its annual members. Which KPI best measures progress toward that goal?
A furniture store made 1,240 deliveries last quarter, and 1,147 of them were received on time. What percentage of its deliveries were received on time? Give your answer as a percent, rounded to one decimal place.
In March, an online tutoring company spent $25,200 on the marketing, advertising and sales it used to win new customers, and it gained 560 new customers. What was its customer acquisition cost, in dollars per customer?
A regional grocery chain's operating profit margin was 6.0% this year, up from 5.2% last year. Grocery chains of its size average 7.5%. Which conclusion is best supported?
A pet-supply store compares four KPIs with the same quarter last year.
- Total sales: up 8%
- Gross profit margin: 41%, the same as last year
- Customer satisfaction rating: 4.6 out of 5, up from 4.4
- Deliveries received on time: 83%, down from 95%
Which goal area most needs the managers' attention?
Course alignment, for teachers
AP Business with Personal Finance topic 4.2, Unit 4: Management and Strategy.