smartKPIs.com Performance Architect update 2/2010

Be smart about SMART goals, SMART objectives, SMART KPIs and smartKPIs

Oftentimes we take things for granted, without asking questions such as:

  • Where did this idea came from?
  • When did it originally emerge?
  • What were the conditions that lead to it?
  • Who contributed to its development?
  • How should it be used properly?
  • Why is it relevant today?

Terms such as SMART goals, SMART objectives and SMART KPIs are today part of the vocabulary in most offices from around the world. smartKPIs is a new term introduced through this website that can be useful in clarifying these concepts. Today’s post will partly address the above questions in terms of the use of the SMART acronym. It will hopefully raise further questions about the slow process of maturing of Performance Management as a discipline.

Theory base

The SMART acronym is one of the most used in business. It has its origins in the Goal Setting Theory school of thought (Locke and Latham, 2002, Locke, 2004). One of the early articles that outlined the benefits of identifying clear goals was published by Edwin Locke, considered along with Gary Latham, one of the fathers of the theory. The article cited studies demonstrating that:

  1. “hard goals produce a higher level of performance (output) than easy goals;
  2. specific hard goals produce a higher level of output than a goal of “do your best”;
  3. behavioral intentions regulate choice behavior.”

(Locke, E. A. ,1968)

Original version of the S.M.A.R.T. acronym

The popularization of the S.M.A.R.T. acronym itself started with an article published in 1981 by George T. Doran, a consultant and former Director of Corporate Planning for Washington Water Power Company, Spokane. In this article, with the title “There’s a S.M.A.R.T. way to write management’s goals and objectives”, he proposed the following criteria a S.M.A.R.T. objective should meet:

  • Specific – target a specific area for improvement
  • Measurable – quantify or at least suggest an indicator of progress
  • Assignable – specify who will do it
  • Realistic – state what results can realistically be achieved, given available resources
  • Time-related – specify when the result(s) can be achieved.

(Doran, 1981)

In addition, Doran made two important notes. First not all objectives must be measured across all levels of management, as in some instances the focus should rather be on the action plan for achieving the objective. Secondly, not every objective written will meet all five criteria. They should be rather seen as guidelines. (Doran, 1981)

SMART goals or SMART objectives

Almost 30 years on, the SMART acronym is widely popular and used. Google searches using the most common keyword combinations returned on 15 January 2010 about:

  • 138,000 results for “SMART goals”
  • 46,100 results for “SMART objectives”
  • 3,970 results for “SMART KPIs”

However, in terms of the initial intent of using the acronym, Doran (1981) inclined towards using the SMART criteria mainly for defining objectives. He acknowledges the following distinction between goals and objectives:

  • Goals represent unique beliefs and philosophies, are usually continuous and long term.
  • Objectives are seen as providing quantitative support and expression to management’s beliefs.

Considering this proposed distinction, the SMART criteria should only be applied to objectives. In practice, however the two terms are used interchangeably by organizations. Doran’s advice regarding this terminology issue is as relevant today as it was 30 years ago:

“Although it may be fashionable to debate the differences between goals and objectives in our graduate business schools, from a practical point of view the label doesn’t make any difference provided officers / managers agree on the meaning of these words. In some cases, goals are short-term and objectives are long-term. In others, the opposite is true. To other organizations, goals and objectives are synonymous. Time should not be wasted in debate over these terms. The important consideration is not to have the label get in the way of effective communication.” (Doran, 1981).

On SMART Key Performance Indicators (KPIs)

While there are many examples of objectives that are incompletely defined and don’t meet the SMART criteria, in the case of KPIs things are different. By its own nature and definition, a KPI is an indicator of performance with the following inherent characteristics:

  • Specific – it has to be specific to an area as it is linked to a process, functional area or preferably an objective, making it a SMART Objective
  • Measurable – it has to be measurable, otherwise it won’t indicate anything
  • Assignable – unless is assigned, it will not me measured
  • Realistic – setting targets is inherent in the documentation and use of KPIs.
  • Time – it is implied in the measurement process

So a KPI shouldn’t even be called KPI if the smart criteria are not met. For this reason, the term SMART KPI is in a way doubling up on the SMART criteria.

smartKPIs

smartKPIs is a term introduced by www.smartKPIs.com to describe the most relevant KPIs in use by organizations, KPIs that are truly “Key” for improving business performance. The term “KPI” has been used with largesse over time and it almost replaced the term “performance measure”. Every KPI is a performance measure, but not all performance measures are KPIs. There are hundreds of measures monitored by organizations, but only a few can be considered “Key”.

Out of these few, there is an even smaller number that is widely used across businesses, for good reasons. They are the “usual suspects” such as:

  • % Customer satisfaction
  • % Employee engagement
  • $ Total revenue
  • $ Net profit
  • % Projects delivered on time, on budget and according to scope

The criteria for smartKPIs are:

  • Being recommended for their usefulness in academic and practitioner publications
  • Frequency of use across Functional areas and Industries
  • Fulfillment of the criteria of how good KPIs should be defined and used.

Considering the “inflation” of KPIs in today’s business environment, identifying these smartKPIs will simplify the selection of relevant KPIs. It will also improve communication by enriching and clarifying a rather confusing glossary of terms that Performance Management as a discipline inherited over time.

Stay smart! Enjoy smartKPIs.com!

Aurel Brudan
Performance Architect,
www.smartKPIs.com

References

Doran, G. T. (1981) “There’s a S.M.A.R.T. way to write management’s goals and objectives”, Management Review, Vol. 70, Issue 11, p35-36, 2p.

Locke, E. A. (1968) Toward a Theory of Task Motivation and Incentives., Organizational Behavior & Human Performance, Vol. 3, Issue 2, p157-189, 33p

Locke, E. A. (2004). “Goal setting theory and its applications to the world of business”, Academy of Management Executive, Vol. 18, No. 4.

Locke, E. A. & Latham G. P., (2002). “Building a Practically Useful Theory of Goal Setting and Task Motivation”, American Psychologist, Vol. 57, No. 9, 705–717.

2009 PMA Conference – Professor Kenneth Merchant: Alternatives to accounting measures

The opening keynote speech of Day 1 of the 2009 Performance Management Association conference was given by, Kenneth Merchant, Deloitte & Touche LLP Chair in Accountancy and Professor of Accounting at the University of Southern California Marshall School of Business. Professor Merchant is an expert in management accounting and management control systems with numerous publications in this field.
His speech addressed the challenges practitioners are faced with in selecting and using performance measures. He discussed the flaws of accounting measures and presented four alternatives.

I have structured below my notes from this session. In part one of this blog post, a number of issues with using accounting measures were presented. Several alternatives answering the question “What to use instead?” are presented below.

Part 2: Alternatives to accounting measures

1. Use market measures of performance.

• They have an obvious appeal.
• They also have some problems due to market imperfections, noise, feasibility (i.e. “market expectations problem”).
• For private firms there is no data availability.

Example: The case of Christopher J. Steffen at Eastman Kodak Co.
• January 1993 – Christopher J. Steffen was appointed Chief Financial Officer (CFO) of Eastman Kodak Co.. He had a reputation of cutting costs. Within 2 days, the stock increased $2.2 billion dollars.
• April 1993 – After 11 weeks in the job, he resigns (with few accomplishments). The stock declines with 2.0 billion dollars.
• Questions: What if the period of stay changes with a few months? Should bonuses be paid for the increase in the stock price due to market reactions?

2. Extend the measurement window

• Extend measurement horizon to 3, 5, even 10 years.
• The analysis of profit / market correlation in different windows (1, 2, 5 10 years) by Easton, et al.
1 year: 0.22
2 years: 0.39
5 years: 0.57
10 years: 0.79
• Are you willing to wait 10 years for a bonus? Maybe not, however 3-5 years is doable.

3. Use more informative non-GAAP financial measures of performance.

• “Pro-forma” earnings – exclude line-items that are more distracting than informative.
• Funds from operations (FFOs) – seems to work with Real Estate Investment Trusts (REITs).
• Free cash flow (FCF).
• Earnings before interest, taxes, depreciation, and amortization (EBIRDA).

4. Use combinations of measures

• There are many different approaches. Market and/or financial and/or non-financial measures.

Measure combination example 1: The GE Management Development and Compensation Committee uses a combination of financial indicators and subjective measures in the list of the CEO Goals and Objectives for 2007 and 2008.

Financial Objectives (Continuing operations)

Revenues
Earnings
Earnings per share (EPS)
Cash from operating activities (CFOA)
Return on trading capital (ROTC)
Margins

Strategic & Operational Goals

Sustain operating excellence and financial discipline.
Create a more valuable portfolio of businesses
Drive organic revenue growth at 2 to 3 times GDP
Retain excellent teams and a strong culture
Manage the Company’s risk and reputation
Build an excellent investor base
Lead the Board activities

Measure combination example 2: The Balanced Scorecard, with up to 20-25 measures, with casual links between them, grouped in four perspectives: Financial, Customer, Internal Business and People, Learning and Growth.
• The majority of firms claim to have a Balanced Scorecard. They misuse the term.
• Which set of measures in that circumstances provide the best indication of the value creation?
• Combination of short-term backward looking measures with leading indicators of future performance.
• How many measures should be used? The function is non-linear:

Ken Merchant-perf-vs-meas

Historical background on the use of measures
1954 – General Motors started using measures – 3-7 measures
1960 – Critical success factors

Conclusions

• Good news: 
o We are accumulating more and more data about the relationship between market related measures, accounting measures and individual non-financial measures (i.e. customer satisfaction).

• Bad news
o Don’t know when to use each of the 4 alternatives presented. Individual or in combination, in any specific period of time.
o Don’t know about the effects of using concurrently multiple performance measures.
o Over satisfying customers is not good either, as this is generating diminishing returns. There is a limit to “profitable” customer satisfaction.
o The benefits of the BSC may not be sustainable (more research is required on what are the long term effects on BSC implementations in the BSC Hall of Fame companies).
o Still lots of research that needs to be done.

Lift-off

The launch of this blog coincides with my attendance at the 2009 Performance Management Association Conference, organised in Dunedin, New Zealand.

Organisational Performance Management is the area in which I am currently focusing my research efforts and the majority of the posts on this blog will be addressing topics under this theme.

In addition this blog will also cover topics from related disciplines and organisational capabilities such as strategy, enterprise architecture, project management, service management and systems thinking.

Image Credit: NASA/U.S. Army