Every business needs to monitor key metrics or Key Performance Indicators (KPIs) that can easily be measured yet can quickly provide the overall direction of where the company is going, or if a part of the business may be going astray.
KPIs are merely a way to separate the “winners” from the “try agains;” and knowing not only what to measure, but also how to measure it and what it all means, is what separates and defines levels of success. We are all familiar with the principle of “You can’t fix what you don’t measure!”
A KPI needs to have the following characteristics to be meaningful:
- a quantifiable measurement that can be tracked and evaluated, and that is harmonious with what you want to achieve
- a metric that an organization measures to help determine its progress towards a goal
- a reflection of the tactical performance of an organization, used to substantiate an organization’s objectives
- quantitative or qualitative, objective or subjective, although preferably quantitative, unambiguous, and reliable
- a critical measurement of the performance of essential tasks, operations, or processes. A KPI will usually unambiguously reveal conditions or performance that is outside the norm and that signals a need for managerial intervention.
I highlighted “reliable” because too often in working with clients, data comes from different sources and often conflicts with actual results. One client presented a key daily report utilized to make buying decisions. When reviewed, the summary page (which management relied on) did not foot to the calculations and was significantly flawed.
When deciding on KPIs to report and track, the usual questions are How Many? and How Often? Initially you don’t want to create an encyclopedia of measurements. Remember they must be critical to essential tasks. Besides corporate KPIs, different departments may need to have their own key measurements. For example, company level KPIs may be demand, sales, expenses, profit, etc. Operations will require others as cost per order, cost per call, phone call abandon rates, receipts processing carryover, returns processing carryover, etc. Merchandising/Inventory will utilize fill rates, cancel rates, backorder rates, margin, inventory turns, overstock, etc. Marketing will measure response rates, average order, email open rates, click thrus/conversion rates, etc. Each area should set their own critical objectives that need to be monitored to be able to identify their respective effectiveness.
Here are a few key metrics critical to merchandising/Inventory:
- Demand – This measures the success of a campaign or offering and a key component of dollar response and average order values. This is the key to what we re-stock, or not! What used to set catalog marketing apart was the ability to capture all demand (what the customer initially wished to buy). Capturing customer’s intent greatly increased planning and forecasting accuracy in the direct marketing world versus retail or web.
Here is an example to highlight the point. A customer browsing a catalog might order Item A and, if out of stock, perhaps settle for a similar Item B or leave. Understanding that Item A brought the customer into the site, future planning would factor and adjust for that to achieve improved service (fill rate) and inventory levels. However, in a retail or web environment where Item A is no longer in stock, it is removed from the customer’s view. The customer looking for Item A may no longer be engaged. Jumping forward, without knowing Item A potential “demand,” future buying would tend to favor Item B and potentially result in overstock.
This common example also impacts marketing results as it potentially depresses response rates, average order values, and conversion rates.
- Fill Rates -These are a measure of ultimate service levels to customer. Initial fill and final fill need to be measured at both the order level and item level. Order level fill is measured as an all-or-nothing and aids the distribution center in projecting split rates (the number of packages per order). Item fill is a guide to inventory control to measure service levels and forecast accuracy. For example, a customer orders three items. Two are in stock and one is on backorder. The initial order level fill would be 0%, however the inventory initial fill rate would be 67%, which tells a different story. If the last item is ultimately shipped, then both measures have achieved a 100% final fill
- Cancel rates – The opposite of fill rates, cancel rates identify customer dissatisfaction and lost sales. An 85 % final fill rate is actually a 15% cancel rate of lost sales. The next step of this metric is to investigate the causes in order to work toward decreasing cancellations, e.g. backorders, out of stocks, etc.
- Return Rates – These need to be measured not only from an inventory standpoint but to make sure that returns are being recognized and addressed. For example, if you have 10 returns on 100 items shipped, that is a 10% return rate. Finance and distribution centers need to know that information in order to measure the cost of handling returns. In addition, if only 7 of the 10 returns are resalable, then inventory management needs to understand that the “return to good stock” rate was 7% and will likely impact subsequent buying decisions.
- Overstock at Cost and Cost of Overstock – The former measures how much overstock is created, and the latter tells you the bottom line impact of the overstock. Knowing these can help in the open-to-buy budgets as well as how much overstock we can “safely” generate and still “liquidate” at above-cost levels. Overstock is a reality of any consumer business. Unfortunately, few direct marketing companies actually create open-to-buy budgets or overstock budgets that are regularly monitored, and yet this metric can have a large impact on profitability.
- Inventory Turns (Inventory Aging) – This measures how quickly you are turning your inventory (i.e. how efficient you are to a just-in-time inventory) and thus has significant implication for cash requirements and inventory aging and cleanliness. Although inventory is a balance sheet asset, and often used as a basis for lines of credit, if a large percentage of total inventory is beyond reasonable timeline usefulness, lenders could revalue the inventory and reduce lines of credit, quickly converting what was once an asset to a large liability.
KPIs are the ways management is able to identify areas requiring immediate attention. In setting KPIs and their target goals, it is important to base them on industry standards and internal history, and most importantly, ensure they are achievable and realistic. If a company has historically achieved a final fill rate of 80% in a season and sets a target of 95% for the subsequent season, of course it would be desirable but unrealistic and could result in a sense of “why try – it’s impossible”? Key Performance Indicators are a way to build cooperation among areas/departments as they all work with consistent, reliable and achievable goals towards the same end.