Setting Up and Using Key Metrics to Evaluate Company Health

Today we hear a lot of talk about key metrics, key indicators, or key measurements. What are these things, why do we need them, and why should we care about them now?

Historically most home builders base business decisions on gut feel vs. performance or facts. Even today, despite the software available on the market and accessibility to data, we are back at the same point with builders making decisions based on gut feel; not because they do not have facts, but because they have too many facts and have no time to sort through it all. Thus, once again we find the builders relying on gut feel to make management decisions.

Builders now have an increased amount of information and reports that can be generated to the point where the critical facts are now buried in cluttered reports. Thus, the need to identify the Key Performance Indicators (KPIs) managers need to evaluate the health of the company and the performance of departments and functional areas has become vital. The proliferation of information has created an overload situation thus the need to sort through the pile of information in search for what is meaningful.

How do I identify my KPIs?

There is not just one key metric that would provide the information management needs to direct the business on the path to success. Even though the net profit ratio is definitely a key metric, by itself it gives a measurement of past performance with little insight about the future or how the company produced the profits. Therefore, we are talking about a group of metrics to provide a complete picture of performance which at the same time, will guide management in predicting the direction of the company and provide insight into the decisions they need to make.

A requirement for meaningful key metrics is a plan, target, goal or objective. A key metric means little if it is not compared with one of these to evaluate performance. Another critical requirement is time. The objective, if at all possible, is to be able to access key metrics in real-time.

The outcome for having and using key metrics needs to be a call to action. It serves no purpose to identify, measure, and report key metrics if no action is initiated to correct or improve the metrics. It is not enough to identify issues and problems; actions are necessary to change the outcome.

The basic requirements to set up or identify critical metrics include the following:

1. Keep it simple, as simple as possible. Everyone should understand how the measurement is calculated. The metrics need to be standard, consistent, and accurate, otherwise, they will be discounted.
2. Make sure there is clear accountability in the following three areas: who is responsible for tracking the metric, who is responsible for the performance of the metric, and who is responsible for implementing the call to action if one is necessary to achieve the target metric.
3. Always compare key metrics with a plan, target, objective and/or prior performance to establish the direction or trend of the metric. This is very helpful in trying to predict the future and to establish successful strategies. Comparisons with industry standards are also helpful.
4. Focus on the critical areas needing management attention and highlight where problems are to direct management to make proper decisions.
5. Make sure the information is timely to allow management more options to respond and to be able to avert major problems.
6. All metrics must be accurate in order to support good decision making.

Which Metrics Should I use?

Metrics can be grouped into external and internal metrics. While companies have little to no control over external metrics, they do have control over how to react to those metrics. Home building companies should be particularly interested in the external metrics at both the national and local levels. The National Association of Home Builders (NAHB), is a source for the national metrics as well as the Commerce Department and a number of economic publications available online or through subscriptions.

At the local level there are several sources available through the including the local Chamber of Commerce, local HBAs, and REALTORS(R), etc. At the local level, one critical source for metrics is the multi-list. We have found that activity in the existing home market foretells activity in the new home market by about three to six months. Key measurements from the multi-list should at least include a trend line on outstanding listings, the average days on the market and the percentage sold price to listing price.

Internal metrics are under management control. We can react to the external metrics and we can alter the internal metrics through our daily decisions. Therefore, it is critical to identify those metrics, measure and track the metrics, compare them to targets, and act on the call to action.

Key areas to develop metrics around include:

• Accounting/Financial
• Sales and marketing
• Inventories
• Production
• Warranty
• Customer Satisfaction
• Human Resources

Every one of the areas represented by a group needs to perform at an acceptable level for the company to be successful. It does not matter if you are a large volume builder, a mid-size builder, a small builder, or a remodeler, if there are failures in any one of these areas, it will cause failure on the other five because they are so interrelated.

We can use the analogy of the pilot control panel: it is no good that the altitude of the plane is set at the target and the wings are set perfectly if the fuel indicator is getting very close to empty. The same occurs in business: we need to have excellent performance in all areas to be able to have excellent performance as a company and be able to sustain operations at a superior level.

Particularly in large companies, metrics can be performed at multiple operational levels starting company-wide, and moving to divisions, communities, product types, departments, and other functional areas. Depending on the size of the company, the levels and areas to identify metrics for will vary. We recommend you segment the company so you are able to maintain clear lines of accountability to those responsible for the performance of each metric.

Summary

To enhance the value of each metric, it is advisable to set up a plan of action identifying targets for each metric. When evaluating the metrics, targets provide the benchmark to grade performance and prepare the report card on how well the company is doing. The report card also provides management direction on how to achieve the desirable goals and objectives. As it is with any system, process, and procedure, the effective use of metrics in managing a company depends on the commitment management has to track, measure and evaluate the metrics and most importantly to respond to the call to action given by the results.

Learn more about KPIs in the on-demand webinar “Understand Key Ratios and the Impacts on Your Profitability” with Emma Shinn.