Business Metrics

The definition of success or effectiveness for an organization is frequently not a simple task: Not only are the criteria of business success complex in most situations, they also frequently change over time. A good metric is a criterion on which the success or failure of a particular aspect of the organization's strategy and concomitant objectives are judged. The development of reliable, valid business metrics that are related to the organization's strategy and objectives is essential for organizational success. One conceptual framework that assists an organization in setting strategy and measuring organizational effectiveness along the vectors of financials, customer relations, internal business processes, and learning and growth is Balanced Scorecard.

By definition, businesses are in business to succeed. The question, however, is how to know when this rather nebulous goal is accomplished. For example, a modest goal upon starting a business may be to grow a consulting practice to the point that there are numerous employees that allow the entrepreneur to be an executive rather than a professional working on projects. After a number of years when the goal is met, the original metric will most likely no longer equate to success. Business goals differ from what they were in the past, based on factors other than pure financial considerations. In fact, financial considerations are rarely the sole determinants of organizational success. For example, some railroads of the nineteenth century met their immediate financial goals by skimping on maintenance of such items as rolling stock and track. Although in the short term their financial goals were met, in the end the maintenance had to be performed and only postponed (and in some cases compounded) the inevitable need for maintenance.

Defining an Organization's Success

The development of business metrics -- objective, quantifiable criteria used to measure some aspect of the organization's performance or effectiveness -- can be a complicated process. Like most real-world problems, the definition of success or effectiveness in an organization is frequently not a simple task. Success on a contract can be defined, for example, as meeting the schedule and staying within budget. However, if by doing so the technical goals of the contract are not met, can the contract performance truly be deemed successful? Similarly, if once the contract is underway unexpected complications are found and more money or time are needed in order to meet the technical goals, do the resultant budgetary or schedule slippages mean that the contract performance was not a success?

In addition, not only are the criteria of business success complex in most situations, they also frequently change over time. An organization that has the same financial goal year after year will probably not be considered to be successful in most cases. Most organizations are constantly seeking for ways to grow and expand and meet ever-changing market needs and demands in order to gain a larger market share. Particularly when other factors such as inflation and cost of living are considered in the calculations, meeting static financial goals cannot always be considered successful.

Business Metrics

The development of objective, meaningful business metrics is essential to the success of the organization. Meaningful metrics are important because without them, one does not know whether or not one's goals are being met. In addition, metrics provide a factual basis for providing quantifiable feedback to show the status of organizational objectives and goals from the various perspectives reflected in the strategic plan. The collection and analysis of business metrics also can be used as diagnostic feedback to guide the organization in continuous improvement of its various business processes, including the identification of trends in performance over time. In addition, the routine collection of data from business metrics can be invaluable in business forecasting methods and the development of models and decision support systems to help managers and other decision makers make the most efficacious decisions as they lead the organization into the future.

Good Metric Criterion

A good metric is a criterion on which the success or failure of a particular aspect of the organization's strategy and concomitant objectives are judged. Criteria are dependent variables or predicted measures (e.g., if we do institute an incentive system, we will produce more widgets) that are used to judge the effectiveness of the organization's processes, policies, and activities in relation to meeting an objective.

• Good criteria are relevant: They are related to an organizational objective and are a valid measure of the status of that aspect of the organization.
• In addition, good criterion measures need to be reliable, yielding consistent measurements time after time. For these reasons, subjective measures such as ratings are less desirable than quantitative data. For example, although one could poll the company's executives to see how well they thought the business was doing, it is rather unlikely that they would each have the same subjective measure in mind when giving an answer. Similarly, subjective measures tend to be nebulous and change over time. Therefore, it is always advisable to get hard data that can be measured and that do not depend on the subjective judgments of people.

Strategic Planning

As difficult as it may be to develop adequate and accurate metrics for business, they are an essential part of strategic planning and goal setting. One cannot improve a process or meet an objective if one cannot operationally define it. To say that Widget Corporation wants to be successful is insufficient: What are the standards against which success will be measured? There is no such thing as the standard set of business metrics. They must be developed based on the requirements and priorities of the organization's strategic plan and then operationally defined in quantifiable terms so that real measures of success or failure can be gathered. This information, in turn, will inform the continuing refining of the organization's strategy.

In business, goals define in practical terms what the organization would like to be within a specific period of time. Strategic planning is the process of determining the best way to accomplish these goals. A good business strategy is based on the rigorous analysis of empirical data, including market needs and trends, competitor capabilities and offerings, and the organization's resources and abilities. In addition, a good business strategy specifies what metrics will be used to measure the success or failure of the organization vis a vis its goals and objectives.

Developing Concrete Terms & Measurable Metrics

Determining the organization's business goals requires an examination of all areas of the firm's functioning. So that the organization is not involved in activities that are not related to the goals of the organization or not contributing to its success, the objectives of the organization need to be expressed in concrete terms and translated into measurable metrics by which progress can be evaluated. Rather than stating that the goal of the company is to "maximize profits and return on investment," "develop new and high quality products," or "meet our corporate social responsibility," specific objectives need to be attached to the broader objectives, stating how success will be determined in measurable, quantifiable terms. For example, rather than saying that the organization is going to increase profits, a well-stated objective would state how much profit the organization is trying to make and the time frame in which this is to be achieved (e.g., "increase profits to $5 million in the next fiscal year").

In order to develop meaningful objectives that will support the organization in reaching its goals, financial concerns should be expressed in terms of objective, measurable results, such as profits, return on investment, earnings per share, or profit-to-sales ratio. For example, financial objectives should be expressed in specific, concrete terms, such as "increase return on investment to 15 percent after taxes within five years" or "increase profits to $6 million before the end of the fiscal year." In addition, well-written objectives should be specific about the market in which these actions will take place. For example, this might include the market share the organization is trying to reach ("increase our share of the market to 28 percent within three years"), dollar amount or unit volume of sales ("sell 200,000 widgets next year"), or industry niche ("increase commercial sales to 95 percent and reduce military sales to 15 percent over the next two years").

However, business metrics should not only be about financial indicators of success as the illustration about postponing maintenance above illustrates. The business strategy might also include a discussion of the productivity necessary to reach these objectives. This might include a ratio of input to output (e.g., "increase number of widgets produced to 100 per eight-hour day") or the cost per unit of production (e.g., "decrease cost of production to $6 per widget"). Similarly, rather than vaguely stating that new products will be developed, a well-stated objective would specify the types of products to be developed and the quality standard to which they are to be developed (e.g., "develop a widget that will automatically mop the floor using a process that yields less than three defects per million").

Applications

Determining Which Metrics to Use

As discussed above, in most cases, business metrics need to be complex and multifaceted. The development of a set of business metrics that will truly reflect the state of the organization and its short- and long-term effectiveness must be both objective and comprehensive. A number of such metrics are commonly used in business, including time to market (for innovation projects), payout or revenue per share, meeting of just-in-time or other lean manufacturing criteria, return on investment (ROI) and return on assets (ROA), sales per customer, turnover per unit of shelf space, sales per store, and return by employee. This list, however, is by no means comprehensive. The metrics that can be used to determine organizational success, effectiveness, or any other goal are as appropriately diverse as the organizations that use them. The trick is to know which metrics are most appropriate in which situation.

Financial Considerations

Many business metrics focus on financial considerations. However, although finances are a good metric for some aspects of the business, they are not the only consideration. A focus on financial criteria was appropriate in the industrial age, when organizational effectiveness could be measured in terms of the number of widgets produced or the profit made per widget. In the information age, however, these metrics are less relevant in many situations. Success and progress toward organizational goals in the postindustrial age must consider other factors such as investments in long-term capabilities and relationships with customers, suppliers, and even the general public. Another characteristic of developing industrial age metrics based on manufacturing processes is that they focus on quality control and the creation of zero defects. Although programs such as total quality management (TQM) and Six Sigma (6s) still have their place, they are often stretched beyond their capabilities when they are applied to service organizations or the products of knowledge workers.

Balanced Scorecard

Another conceptual framework that assists an organization in setting strategy and measuring organizational effectiveness along the vectors of financials, customer relations, internal business processes, and learning and growth is the balanced scorecard. This system helps organizations clarify their vision and translate them in to concrete actions. In addition, balanced scorecard provides organizations with the feedback necessary so that they can continuously improve their business processes and performance in an attempt to meet their strategic goals and objectives.

As shown in Figure 1, the balanced scorecard takes these considerations into account and builds upon the successes of previous approaches to develop metrics evaluation methods that are more appropriate to twenty-first-century businesses. The balanced scorecard approach to measuring organizational effectiveness looks at organizational success and effectiveness from four perspectives: learning and growth, business process, customer, and financial. In addition, the balanced scorecard includes not only a feedback loop around internal business process outputs, but a second feedback loop around the outcomes of business strategies.

Learning & Growth

In an age of knowledge explosion and technological innovation, it is essential that both the organization in general and its employees stay current so that it can keep pace not only with its industry but with changing business models and processes. Particularly in service organizations and for those whose primary product is knowledge, it is imperative that the organization be able to stay on the cutting edge of its field in order to gain or maintain a competitive advantage over the competition. In such organizations, the primary assets are the employees and their knowledge. Therefore, continual learning is essential to the success of the organization. The learning and growth perspective of the balanced scorecard takes this fact into account and looks at metrics that measure how well the organization is maintaining an ability to change and improve. Metrics for this aspect of business success focus on the use of training funds and utilizing them where they can do the best vis à vis the organization's goals and objectives. Learning and growth in this approach, however, include more than formal classroom training. Other activities that can help the organization succeed include mentoring programs and ease of communication from both a technological point of view (e.g., through the company intranet) and through skills training for the employees. Metrics should be put in place to measure these things.

Business Processes

Business processes are any of a number of linked activities that transform an input into the organization into an output that is delivered to the customer. Business processes include management processes, operational processes (e.g., purchasing, manufacturing, marketing), and supporting processes (e.g., accounting, human resources). The business process perspective in balanced scorecard looks at the internal business processes of the organization and develops metrics that enable managers to better understand how well the organization is running and the extent to which the resultant services and products meet the objectives and goals of the organization. Specifically, these metrics should examine the strategic management processes, mission-oriented processes, and support processes. To be optimally useful, these metrics should be designed by those who understand the processes best.

Customer Focus

No matter how well an organization is running or how knowledgeable its employees are, if no one buys its good or services, the organization will fail. As the number of service organizations rises and organizations need to successfully interact with their customers, customer focus and customer satisfaction become increasingly important. Frequently, there is little to differentiate the offering of one organization from that of another. What sets organizations apart from each other in such situations, therefore, is their reputation as perceived by the customer. The customer perspective of balanced scorecard takes this fact into account. Customer satisfaction, however, is a complex thing, and the development of metrics for this aspect of organizational effectiveness needs to take all relevant aspects into account, including customer type and characteristics and the interaction of the various organizational business processes that provide a product or service to these groups.

Financials

The final type of metric that should be considered in monitoring business effectiveness is financials. Although, as discussed above, other aspects of the organization's functioning are important, they do not obviate the need for considering the financial success and viability of the organization. However, financial considerations should not be limited to profit-and-loss statistics, but should also take into account other factors such as risk assessment and cost/benefit data to paint a more complete picture of organizational effectiveness and success.

Conclusion

The development of business metrics can be a complicated process. Criteria of business success are typically complex and also frequently change over time. However, the development of objective, meaningful business metrics that are both objective and comprehensive is essential to the success of the organization. These metrics should be based on the organization's strategic plan and concomitant objectives. Particularly in the information age, these metrics need to take into account not only financial considerations as measures of success, but other measures as well.

Terms & Concepts

Balanced Scorecard: A conceptual framework that assists an organization in setting strategy and measuring organizational effectiveness along the vectors of financials, customer relations, internal business processes, and learning and growth.

Business Metric: An objective, quantifiable criterion used to measure some aspect of the organization's performance or effectiveness.

Business Process: Any of a number of linked activities that transforms an input into the organization into an output that is delivered to the customer. Business processes include management processes, operational processes (e.g., purchasing, manufacturing, marketing), and supporting processes, (e.g., accounting, human resources).

Competitive Advantage: The ability of a business to outperform its competition on a primary performance goal (e.g., profitability).

Decision Support System (DSS): A computer-based information system that helps managers make decisions about semistructured and unstructured problems. Decision support systems can be used by individuals or groups and can be stand-alone or integrated systems or web based.

Just-in-Time Manufacturing (JIT): A manufacturing philosophy that strives to eliminate waste and continually improve productivity. The primary characteristics of JIT include having the required inventory only when it is needed for manufacturing and reducing lead times and set up times. Also called "lean manufacturing."

Model: A representation of a situation, system, or subsystem. Conceptual models are mental images that describe the situation or system. Mathematical or computer models are mathematical representations of the system or situation being studied.

Reliability: The degree to which a psychological test or assessment instrument consistently measures what it is intended to measure. An assessment instrument cannot be valid unless it is reliable.

Return on Investment (ROI): A measure of the organization's profitability or how effectively it uses its capital to produce profit. In general terms, return on investment is the income that is produced by a financial investment within a given time period (usually a year). There are a number of formulas that can be used to calculate ROI. One frequently used formula for determining ROI is (profits-costs) / (costs) × 100. The higher the ROI, the more profitable the organization.

Risk Assessment: The process of determining the potential loss and probability of loss of the organization's objectives. Risk assessment is one step in risk management.

Six Sigma (6s): An approach to improving quality. The term "six sigma" is a statistical term referring to the degree to which a product reaches its quality goal. At six sigma, a product is reaching its quality goal 99.9999997 percent of the time, or has only 3.4 defects per million. The Six Sigma system was originally developed by Motorola.

Strategic Planning: The process of determining the long-term goals of an organization and developing a plan to use the company's resources -- including materials and personnel -- in reaching these goals.

Strategy: In business, a strategy is a plan of action to help the organization reach its goals and objectives. A good business strategy is based on the rigorous analysis of empirical data, including market needs and trends, competitor capabilities and offerings, and the organization's resources and abilities.

Total Quality Management (TQM): A management strategy that attempts to continually increase the quality of goods and services as well as customer satisfaction through raising awareness of quality concerns across the organization.

Validity: The degree to which a survey or another data collection instrument measures what it purports to measure. A data collection instrument cannot be valid unless it is reliable.

Bibliography

Arveson, P. (1998). What is the balanced scorecard? Balanced Scorecard Institute. Retrieved October 3, 2007, from http://www.balancedscorecard.org/basics/bsc1.html

How do you work with the CEO or CMO to identify which metrics matter most?. (2012). PRWeek (U.S.), 15(2), 51-52. Retrieved November 20, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=71941925

Landy, F. J., & Conte, J. M. (2004). Work in the 21st century: An introduction to industrial and organizational psychology. Boston, MA: McGraw Hill.

Measurement is the first step in the process. (2013). CRM Magazine, 17(10), 15. Retrieved November 20, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=90681344

Seven deadly sins of business metrics. (2011). Executive Leadership, 26(7), 8. Retrieved November 20, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=69615948

Suggested Reading

Hanley, S., & Malafsky, G. (2004). A guide for measuring the value of KM investments. In C. W. Holsapple (Ed.), Handbook on knowledge management 2: Knowledge directions (pp. 369-390). Retrieved October 3, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19433217&site=bsi-live

Hindle, T. (2003). Balanced scorecard. In Guide to management ideas (pp. 3-4). New York, NY: Bloomberg Press. Retrieved October 3, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26023545&site=bsi-live

Jacobs, R., & Goddard, M. (2007). How do performance indicators add up? An examination of composite indicators in public services. Public Money and Management, 27(2), 103-110. Retrieved October 3, 2007, from EBSCO Online Database Business Source Complete. http://search.ebsco-host.com/login.aspx?direct=true&db=bth&AN=24488073&site=bsi-live

Kaplan, R. S., & Norton, D. P. (2007). Using the Balanced Scorecard as a strategic management system. Harvard Business Review, 85(7/8), 150-161. Retrieved October 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=25358567&site=bsi-live

Upton, D. R. (2012). Experimental Balanced Scorecard research: Implications for practitioners. Management Accounting Quarterly, 13(4), 25-31. Retrieved November 20, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=82600883

Wang, Y. G., Yi-Min, L., Chyan-Long, J., & Kuang-Wen, C. (2013). Evaluating firm performance with Balanced Scorecard and data envelopment analysis. WSEAS Transactions On Business & Economics, 10(1), 24-39. Retrieved November 20, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=88117273