What is the goal of using opportunity cost as a key performance indicator?

Importance of KPIs

Key performance indicators shine a light on how well a business is doing. Without KPIs, it would be difficult for a company's leaders to evaluate that in a meaningful way, and to then make operational changes to address performance problems. Keeping employees focused on business initiatives and tasks that are central to organizational success could also be challenging without designated KPIs to reinforce the importance and value of those activities.

In addition to highlighting business successes or issues based on measurements of current and historical performance, KPIs can point to future outcomes, giving executives early warnings on possible business problems or advance guidance on opportunities to maximize return on investment. Armed with such information, they can manage business operations more proactively, with the potential to gain competitive advantages over less data-driven rivals.

Types of KPIs

KPIs that measure the results of business activities, such as quarterly profit and revenue growth, are referred to as lagging indicators because they track things that have already occurred. By comparison, KPIs that herald upcoming business developments -- say, sales bookings that will generate revenue in future quarters -- are known as leading indicators.

There's also a difference between quantitative indicators that have a numerical basis and qualitative indicators that are more abstract and open to interpretation, such as assessing user experience with a product or on a website. In the case of qualitative indicators, identifying useful KPIs can be challenging; the selection of appropriate ones depends on an organization's ability to actually measure them in some way. For example, the percentage of abandoned transactions in online shopping carts might be one indicator of customer experience on a retail website.

From a functional standpoint, key performance indicators encompass a wide variety of financial, marketing, sales, customer service, manufacturing and supply chain metrics. KPIs can also be used to track performance metrics related to internal processes, such as HR and IT operations.

How to measure KPIs

Once key performance indicators have been identified, they should be clearly communicated to employees so all levels of the organization understand which business metrics matter the most and what constitutes successful performance against them. This could include the entire workforce on broad corporate KPIs or smaller groups of workers on ones that apply to particular departments.

In most companies, KPIs are automatically tracked via business analytics and reporting tools that collect relevant data from operational systems and create reports on the measured performance levels. Increasingly, KPI results are presented to executives on business intelligence dashboards or performance scorecards that often include charts and other data visualizations, with the ability to drill down into the performance data for further analysis. Multiple KPIs also underlie balanced scorecard frameworks that pull together sets of metrics in an effort to provide a broader view of business performance beyond operating income and other common financial measurements.

One of the challenges in setting key performance indicators is deciding how many to track to determine organizational success. Having too many KPIs may dilute the attention paid to the truly important ones. As a result, it may be more effective to limit the scope to small sets of indicators.

Managers must continually evaluate KPIs to ensure they're still relevant and aligned with priorities in business operations. If individual KPIs no longer serve a useful purpose, they need to either be refined or replaced altogether.

Examples of key performance indicators

Beyond revenue, expenses and profit, commonly used financial KPIs include gross and net profit margin, which measure how much money a company makes on sales of products; inventory turnover, which tracks how quickly products held in inventory are sold; cost of goods sold, a measure of the materials and labor costs incurred in making products; accounts receivable turnover, a ratio that quantifies how quickly payments on credit sales are collected from customers; and days sales outstanding, a related metric which gauges the number of days' worth of receivables that have yet to be collected.

Marketing and sales KPIs include lead conversion rate, which measures the percentage of sales leads that are successfully turned into customers; customer acquisition cost, which calculates the average cost of acquiring new customers in marketing and sales expenses; return on marketing investment, for quantifying the financial payback of marketing campaigns and programs; customer lifetime value, a prediction of the total profit a company is likely to make from sales to individual customers; and customer churn rate, a measurement of how many customers stop buying a company's products.

Key performance indicators in customer service call centers include first-call resolution rate, which tracks the percentage of incoming inquiries from customers that are addressed without the need for additional calls; cost per call, for quantifying the average cost of handling calls; call volume, which measures the total number of calls handled during a particular period; hold time, a measure of the average time customers spend on hold during calls; and call abandonment, the rate at which customers hang up while waiting on hold.

KPIs for manufacturing and supply chain operations include the percentage of defective products made by a company; manufacturing cycle time, which measures how long it takes to make products; carrying cost, which puts a value on what it costs to keep products in inventory; percentage of out-of-stock items, for tracking the number of products that aren't available in inventory when customers order them; back-order rate, a related metric quantifying the number of orders that can't be filled when they're placed; and return rate, which assesses the percentage of items that are returned.

HR departments track key performance indicators such as employee satisfaction levels and turnover rates, while the KPIs that IT managers look at include system uptime, compliance with service-level agreements, on-time project completion rates and average resolution time on help desk tickets.

Industry-specific KPIs have also been created in retail, healthcare, financial services and other markets. For example, a retailer might track things such as the average purchase value of sales transactions and sales per square foot of brick-and-mortar retail space, while a healthcare organization might measure emergency room wait times, the average length of stay in a hospital and patient readmission rates, among other metrics.

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