A colleague of mine sent me the following cartoon that made me laugh. The very talented cartoonist Tom Fishburne sketches tongue-in-cheek how people tend to view key performance indicators (KPIs).
Figure 1 – “KPI Overload” by Tom Fishburne at www.marketoonist.com
As a Performance Based Contracting (PBC) practitioner I cannot remember the number of times I have experienced this exact circumstance. So why am I bringing it up? For over 15 years people constantly ask me how many KPIs should my contract have? Unfortunately, no single number or magical formula will make our lives easier. But, more importantly, I think it’s the wrong question.
To be honest, the first question should be what are KPIs and why do we use them? One article1 puts it this way:
Key Performance Indicators represent a set of measures focusing on the aspects of organizational performance that are most crucial for the current and future success of the organization.
KPIs are therefore focused either on the critical aspects of organizational performance that require improvement, or on the aspects that must be kept within a specified level to ensure the continued success of the organization.
But shouldn’t more KPIs be better? For example, having more KPIs means the buyer gets additional performance information, including the associated performance drivers and risks, leading to better oversight, control and assurance of seller performance. However, more KPIs is not without costs, including the increased cost of collecting, analyzing, reporting and storing information.
Interestingly, more KPIs can also lead to confusion and loss of control with the buyer distracted from critical performance issues with numerous indicators, some masking true performance. Alternatively, having too many performance measures may result in the buyer interfering (micro-managing) the seller’s delivery of performance potentially resulting in more disputes and damaging the business relationship. A summary of these benefits and costs is illustrated in Figure 2
Figure 2. Benefits versus costs of using performance measures
Given this, perhaps the next question might be, how do we go about balancing the benefits of using performance measures versus the costs of using them?
On method is to use the science of human factors engineering2 to determine the optimal number of performance measures. This field examines the cognitive workload on humans describing the optimal amount of activities, including complexity of each activity, allowing humans work at their best. For example, in both the defence and aerospace sectors, much of this research and the associated “standards” drive how the various instruments and controls are positioned in aircraft, helicopters and spacecraft.
The famous 1956 paper titled, The Magical Number Seven, Plus or Minus Two: Some Limits on Our Capacity for Processing Information,3 by George A. Miller observed that through a variety of studies our short-term memory had a capacity of about "seven plus-or-minus two" chunks. These chunks represented a concept or thought as opposed to a single value. However, other research found that this study was sometimes overly optimistic and perhaps the real value was as low as four.
Accordingly, it is possible to apply this thinking to our problem of how many performance measures we should use.
First, if it makes sense for your contract, I recommend you divide (or “chunk”) the performance measures into different tiers reflecting their utility, potentially using a 3-tiered approach based on:
- Strategic Performance Measures (SPMs) or Enterprise Performance Measures (EPMs);
- Key Performance Indicators (KPIs); and
- System Health Indicators (SHIs).
You can learn more about each of these tiers, including their role and responsibility in my other recently published articles.4
Second, limit the number of performance measures for each of the tiers, -- especially the SPMs and KPIs which will get the most attention -- to between 3 and 5, or perhaps up to 7.
If the performance measures are simple, intuitive and easily understood -- including objective, quantitative or common, industry standard performance measures – I recommend using the higher band (e.g. between 5 – 7). But, if the performance measures are more complex and harder to understand -- including subjective, qualitative or bespoke performance measures -- I recommend using the lower band (e.g. between 3 and 5).
Finally, in setting the total number of performance measures avoid combining multiple performance measures into a single measure in an attempt to minimize your total number of performance measures. For example, KPI1 is made up of KPI1.1 and KPI 1.2 and KPI 1.3, etc.
So when considering how many performance measures you should have in your contract keep in mind the words of the American actress Julie Newmar:
“More is not necessarily better. Better is better.”
It is better to deliberately and consciously consider what is the optimal number of performance measures for your contract, including how they aggregated, rather than simply apply a “magic number”. But which performance should you choose? That is a question for another time.
- Key Performance Indicators Manual: A Practical Guide for the Best Practice Development, Implementation and Use of KPIs, AusIndustry, Pittman Publishing, 1995
- Articles published in my Performance Based Contracting blog and my most recent articles published in IACCM’s Contracting Excellence Journal (CEJ).