Are your Key Performance Indicators destroying your organizational effectiveness? Sadly, in many companies they are definitely getting in the way of optimal effectiveness. How can this be true, I hear you say? After all, the whole point of KPI’s are to enable management to measure and ensure that everyone is doing their job to the best of their abilities. While that is true it does not take into account the number of times that organizations have conflicting objectives and therefore conflicting measures. From the very beginning of organizational development thousands of years ago everyone has worked from the theory that if every department is as efficient and effective as possible than the organization will be as efficient and effective as possible. Unfortunately this just is not true.
Let’s look at the example of two departments in company A – Production and Inventory Control. Management has decided on a strategic cost saving change for the company that involves reducing the average inventory value. Because of the new strategy, new objectives and therefore new KPI’s are set in Inventory Control to meet the new requirements. They take the easy first step and reduce significantly the amount of Dead & Slow Moving Inventory (DSMI). They then move on to reducing the raw material inventory but find that this creates problems with production running short of requested material. In addition they also find that they cannot reduce finished goods inventory as they have no control over the finished goods produced regardless of the production plan. The reason for both of these issues is that production consistent over produces against the plan which produces overstock in finished goods and uses more raw materials than was planned for. Upon investigation it is found that the reason for the over production is that there is a policy of only doing changeovers after regular work hours. This means they keep producing to the end of the day no matter when they finish the quantity ordered. In order to resolve the issue management decides to change the policy so that production stops and changes over as soon as the proper quantity is produced. This is wonderful for the Inventory Management group as excess inventory starts to drop quickly, emergency orders for raw material also drop and usage becomes consistent with the plan which means that safety stock can also be decreased which further reduces inventory. They are now meeting the new measures for inventory levels and everyone is happy now… right? No, everyone is not happy. The main KPI measure for production is almost always efficiency and this change would probably cause their efficiency rating to drop significantly so they are not achieving their key measure. Remember, bonuses (as in money) are almost always tied to the KPI and people pay far more attention to their own paycheque than to the company’s overall effectiveness. This means that over time production is going to slowly start overproducing again in order to get their efficiency measure up. As production slowly drift back to the way they were before the change, inventory drifts up, safety stock drifts up, emergency orders drift up, etc. And as these all drift up, Inventory Management slowly drifts away from their key measure of lower inventory. All these issues are happening because of conflicting measures between the two departments.
What about all the other departments in the organization? Do they have any conflicting objectives and measures as well? Probably as this tends to be a very common issue. It is absolutely imperative that all departmental objectives and measures within an organization are synchronized with each other. In the above example, establishing a KPI around conformance to the production plan and giving it a higher rating than efficiency would have eliminated the problem. Sometimes making one area less efficient makes another area more efficient. It is how the sum of all the departments efficiencies work out that defines whether a company is optimally effective or not. This is one of the failures of programs like Lean Manufacturing – sometimes waste is a good thing. For instance, excess inventory in front of a bottleneck operation is desirable, NOT a waste. Excess capacity can equal increased flexibility which can be a competitive advantage. The trick is always in the balance, in understanding how much excess is a good thing and reflecting this in the KPI’s for the organization.
One final point, while much of this is the responsibility of upper management to build a culture of maximum effectiveness by interlocking objectives it is middle management that ultimately has control of each department’s objectives and measures. If they are not working together to identify and eliminate conflicting measures then it is not going to happen. This means the organization will continue to limp along, never quite being as good as they can which makes the organization vulnerable to outside competitive pressure. When it comes to KPI’s the organization MUST look at the bigger picture and not let each individual department set their own goals.
Having issues with your inventory?
Do you understand what Drivers are biasing your inventory levels to move up or down? Do you need help understanding and getting control of your inventory? Contact Ed White at Jade Trillium Consulting to discuss whether we can help your organization and how best to proceed.
Hope you enjoyed this posting. Talk to your friends and co-workers about their experience and thoughts on this topic, especially what it means for your organization. And, as always, I would love to hear back on your (and their) thoughts. Just fill in the comment box below along with your contact information to let me know what you think.