How Many KPIs Should My Contract Have? – Part 2

In the previous article (see How Many KPIs Should My Contract Have? – Part 1) we examined the benefits and costs of using performance measures.  In this article we are going to examine how to balance the benefits versus the costs of using them .

On method is to use the science of human factors engineering to determine the optimal number of performance measures.  This field examines the cognitive workload on humans describing the optimal amount of activities, including complexity of each activity, allowing humans work at their best.  For example, in the defence and aerospace sector, much of this research and the associated “standards” drive how the various instruments and controls are positioned in aircraft, helicopters and spacecraft.

The famous 1956 paper titled, The Magical Number Seven, Plus or Minus Two: Some Limits on Our Capacity for Processing Information, by George A. Miller observed that through a variety of studies our short-term memory had a capacity of about “seven plus-or-minus twochunks.  These chunks represented a concept or thought as opposed to single value.  However, other research found that this study was sometimes overly optimistic and perhaps the real value was a low as four.

Accordingly, it is possible to apply this thinking to our problem of how many performance measures we should use.

Firstly, if it makes sense for your contract, I recommend you divide (or chuck) the performance measures into different tiers reflecting their utility, potentially using a 3 tiered approach based on Strategic Performance Measures (SPMs) / Enterprise Performance Measures (EPMs), Key Performance Indicators (KPIs) and System Health Indicators (SHIs).  You can learn more about each of these tiers, including their role and responsibility, from previous articles (see When is a KPI not a KPI?).

Secondly, limit the number of performance measures for each of the tiers, especially the SPMs and KPIs which will get the most attention, to between 3 and 5, or perhaps up to 7.  Where the performance measures are simple, intuitive and easily understood, including objective, quantitative or common, industry standard performance measures, it is possible to use the higher band (e.g. between 5 – 7).  However, where the performance measures for more complex and harder to understand performance measures including subjective, qualitative or bespoke performance measures, the lower band is recommended (e.g. between 3 and 5).

Finally, in setting the total number of performance measures avoid combining multiple performance measures into a single measure in an attempt to minimize your total number of performance measures.  For example, KPI1 is made up of KPI1.1 and KPI 1.2 and KPI 1.3, etc.

So when considering how many performance measures you should have in your contract keep in mind the words of the American actress Julie Newmar:

“More is not necessarily better. Better is better.”

It is better to deliberately and consciously consider what is the optimal number of performance measures for your contract, including how they aggregated rather than simply applying a “magic number”.  But which performance should you choose?  That is a question for another time.

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How Many KPIs Should My Contract Have? – Part 1

A colleague of mine sent me the following cartoon that made me laugh.  The very talented cartoonist Tom Fishburne sketches tongue-in-cheek how people tend to view key performance indicators (KPIs).

Figure 1 – “KPI Overload” by Tom Fishburne at http://www.marketoonist.com

As a Performance Based Contracting (PBC) practitioner I cannot remember the number of times I have experienced this exact circumstance.  So why am I bringing it up? For over 15 years people constantly ask me how many KPIs should my contract have?  Unfortunately, there is no single number or magical formula that will make our lives easier. But, more importantly, I think it’s the wrong question.

To be honest, the first question should be what are KPIs and why do we use them?  The Key Performance Indicators Manual: a Practical Guide for the Best Practice Development, Implementation and Use of KPIs by AusIndustry (part of the Australian Department of Industry, Science, Energy and Resources) defines KPIs as:

Key Performance Indicators represent a set of measures focusing on the aspects of organisational performance that are most crucial for the current and future success of the organisation.

KPIs are therefore focused either on the critical aspects of organisational performance that require improvement, or on the aspects that must be kept within a specified level to ensure the continued success of the organisation.

But shouldn’t more KPIs be better?  For example, having more KPIs means the buyer gets additional performance information, including the associated performance drivers and risks, leading to better oversight, control and assurance of seller performance.  However, more KPIs is not without costs, including the increased cost of collecting, analysing, reporting and storing information.  Interestingly, more KPIs can also lead to confusion and loss of control with the buyer distracted from critical performance issues with numerous indicators, some masking true performance.  Alternatively, having too many performance measures may result in the buyer interfering (micro-managing) the seller’s delivery of performance potentially resulting in more disputes and damaging the business relationship.  A summary of these benefits and costs is illustrated in Figure 2.

Figure 2 – Benefits vs. Costs of Using More Performance Measures

Given this, perhaps the next question might be, how do we go about balancing the benefits of using performance measures versus the costs of using them?  We will look at that in the next part of the article.

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Release of PBC Awareness Video

After a lengthy delay I am proud to announce that my first video on Performance Based Contracting (PBC) is now available free for your viewing pleasure; PBC Awareness.  The video provides viewers a 35 minute introduction to PBCs using a presentation format with voiceover explaining each slide.  The intent of the presentation is to provide viewers an insight into the purpose, key features and details of this style of contract.

This will be the first in a series of videos over the next year.  While my family suggested I do not call this series “Phun with PBC”, the videos that follow this one will build on it and cover specific topics in more detail.  If you have any areas that you would like me to cover, please let me know.

Anyway, I hope you enjoy it and forgive my Australian accent!

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Guest Presentation on Managing a Performance Based Contract during Free Online Course from IACCM

While I usually don’t advertise on this Blog, the International Association of Contract and Commercial Management (IACCM) are once again offering a free Massive Open Online Course (MOOC) on Contract Management: Build Relationships in Business.  This free online course is scheduled to run from 25th May 2020 – 14th June 2020 and is designed for anyone who wants to better understand what is involved in commercial business relationships, and the process of managing contractual agreements.

The reason I am mentioning this course on my Performance Based Contracting (PBC) Blog is that I am one of the guest presenters during the event talking about Managing a PBC.  The topic of my short 1 hour presentation covers the following area:

Performance Based Contracts (PBCs) have proven to be an effective tool in reducing overall costs for buyers and providing profitable growth opportunities for sellers making it the contract model of choice across a range of market sectors.  While deceptively simple, PBCs are different to conventional contracts and require a different approach to their development, implementation and management.  The ability for organisations to effectively develop, implement and manage PBCs is critical to business success as failure can often lead to long-term performance, financial and reputational damage.

I hope to see you there.

(Disclosure – I am a Fellow and part of the IACCM Australia and New Zealand Advisory Board.  These are non-financial positions and my guest presentation is being offered for free as part of my vision to create a PBC Community of Practice to help advance this fascinating field).

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Introducing the Power By The Hour Approach

In designing a Performance Management Framework (PMF) for a new Performance Based Contract (PBC) the team asked about using a “Power by the Hour”™ approach and asked my opinion.  Given the general similarity between Power by the Hour and PBC I thought it a good area to discuss.

So what is Power by the Hour?

Firstly, Power by the Hour is a trademarked term used by Rolls-Royce, the global power systems company.  The term was invented in 1962 to support the Viper engine on the de Havilland/Hawker Siddeley 125 business jet.  Unlike previous approach of airlines buying the engine as part of the aircraft and then having a separate maintenance contract to support it, Power by the Hour offered airlines a new option.  That is, a complete engine and accessory replacement service on a fixed-cost-per-flying-hour basis.

While Rolls-Royce’s Power by the Hour approach has become more sophisticated since it’s introduction in 1960’s, from a behavioural perspective a Power by the Hour approach remains simple.  If the engine is working, there is a high chance that the aircraft is flying and generating revenue for the airline.  In this case, a working engine would also be generating revenue for Roll-Royce.  However, if the engine is not working with the aircraft sitting on the ground, there is no revenue for either the airline or Rolls-Royce.  This approach aligns the needs of both buyer and seller; that is, when the engine in working and the aircraft is flying, this makes money for both the airline and Rolls-Royce.

But why are we talking about Power by the Hour approach in a PBC Blog?

In a previous article (see Designing Successful Performance Based Contracts) I suggested that highly successful PBCs had the following characteristics:

  1. drives the right behaviour in the seller by addressing the Seller’s Needs;
  2. provides adequate commercial protections for the buyer by addressing the Buyer’s Needs; and
  3. balances the needs within a usable Commercial Construct (i.e. the contract).

This is achieved by aligning the Seller’s Needs against delivery of the Buyer’s Needs as reflected in the Commercial Construct.

A Power by the Hour approach delivers these three characteristics by aligning Rolls-Royce’s payment (i.e. the Seller’s Needs) with working engines (i.e. the Buyer’s Needs) all within the commercial construct (i.e. the contract).  In doing so, a Power by the Hour approach is an elegant approach to delivering a highly successful PBC.

Given this, can a Power by the Hour approach work in other situations and if so, what are the Critical Success Factors and constraints that must be considered?

In the next article I will look at a Power by the Hour approach in a more generic manner including how this relates to modern “as a Service” approaches to contracting.

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Corporate Social Responsibilities (CSR) or 1 + 1 = 3

At the 2020 World Economic Forum held between 20-23 January 2020 in the mountain town of Davos, governments, organisations (both for profit and not-for-profit) and individuals discussed how they can better deliver the United Nations Sustainable Development Goals (SDGs).  Central to this discussion was how innovative partnerships (i.e. commercial relationships) could help achieve this, especially within the public sector.  But why is the focus on public sector so important?

Supporting this discussion, The Economist Intelligence Unit (EIU) supported by UNOPS (the UN organisation with a core mandate for infrastructure and procurement) released a new report “The future of public spending: Why the way we spend is critical to the Sustainable Development Goals”.  The report investigates the potential for less wasteful, more efficient government spending practices to help address a critical spending gap that countries face in achieving the Sustainable Development Goals, and how social, environmental and economic sustainability objectives can be achieved through procurement.  This report highlighted that:

“Public spending has an extremely large footprint, typically representing 15-30% of GDP. Which projects governments choose to spend money on—and who they spend it with—therefore makes a substantive difference. Rather than being “neutral”, such spending will positively or negatively impact everything from local employment to levels of carbon emissions, making public spending integral to many of the SDGs.”

Here in Australia, the Commonwealth Procurement Rules (CPRs) requires all Commonwealth entities to publish a range of procurement information on AusTender, the Commonwealth Government’s mandated procurement information.  My former organisation, the Australian Department of Defence, between July 2018 and June 2019 was responsible for 67% of all procurements listed on AusTender, or $43.178 Billion Australian Dollars (see Department of Finance).  This proportion (not value) would be similar in many countries.  The key question is whether we can use this funding to achieve more than the original contract requirement(s).  Is it possible to achieve both the project requirements while also delivering wider community benefits?

In considering this, many of you, regardless of whether buyer or seller, will be asking the impact of this approach on the overall price.  Will it cost more?  While there is anecdotal evidence to say there typically is a slight increase in the overall price to the buyer, the question is not whether this approach represents the lowest price.  It never will.  But whether it represents the best Value for Money (VfM) in the long-term, and not only to the specific area undertaking the procurement activity, but also the wider department and community.  Indeed, the reason for the focus on the public sector at Davos is that many governments have recently included this additional requirement is their procurement rules.  For example, the CPRs states:

4.5       Price is not the sole factor when assessing value for money. When conducting a procurement, an official must consider the relevant financial and non-financial costs and benefits of each submission including, but not limited to:

  • the quality of the goods and services;

  • fitness for purpose of the proposal;

  • the potential supplier’s relevant experience and performance history;

  • flexibility of the proposal (including innovation and adaptability over the lifecycle of the procurement);

  • environmental sustainability of the proposed goods and services (such as energy efficiency, environmental impact and use of recycled products); and

  • whole-of-life costs.

Additionally, a recent change to the CPRs states that for “for procurements above $4 million (or $7.5 million for construction services) (except procurements covered by Appendix A and procurements from standing offers), officials are required to consider the economic benefit of the procurement to the Australian economy.”

But why am I bringing this up in a Performance Based Contracting forum?

A good Performance Based Contracting approach can support the implementation of these wider procurement objectives.  As one of my favourite quotes goes:

“What gets measured gets done, what gets measured and fed back gets done well, and what gets rewarded gets repeated.”

John E. Jones

By using the Generation 3 Performance Based Contracting techniques I have illustrated in this blog including:

it is possible to achieve this.

For example, a client in Europe recently included performance measures called Enterprise Performance Measures (EPMs) reflecting the performance of the wider “enterprise” compared with the performance of one seller in a single contract.  The EPMs are not solely focused on the core output of the contract, but also on wider Corporate Social Responsibilities such as the impact on the environment (e.g. minimisation of landfill and carbon targets) to building a better community (e.g. collaboration, engagement and treatment of small-medium businesses within the supply chain, and the implementation of a Science, Technology, Engineering and Maths (STEM) program in local schools).  So it is possible, just not typical.

Some of you may be thinking that organisations, especially for profit organisations are only doing this in response to the “nudge” from the buyer.  And in some ways that is true.  A former top executive within the Australian Department of Defence once said, referring to his for profit contractors, that “what interests me should fascinate them”.  By this he meant if we (the buyer) focused on these wider outcome it would cause the sellers to also take an interest in delivering them.  However, and it may surprise many readers, some these organisations already do a range of community minded activities without the “nudge”.  For example, one large multi-national organisation as part of an annual “day of service” allows employees to volunteer in areas of need in their local communities (e.g. aged care, home repairs, supplying meals and many other forms of assistance) as a paid day of work.

The sceptical amongst you will be thinking that this behaviour is only to gain favour with the public sector procurement officer, and there is an element of truth to this.  However, these organisations are all made up of individuals with families in the communities where they work who also believe in the ideals in the Sustainable Development Goals.  These individuals help make this a priority for the organisation, not simply to gain favour, but because it is important to the people within it.

So the question I leave with each of you, regardless whether buyer or seller, is not why should we; but why shouldn’t we.  Image what could happen if we allowed these large commercial relationships to deliver, even if only partly, on these wider outcomes.  I believe that many of us want this not just for ourselves and our families, but also for the wider community.  The question is simply how do we do it leveraging the great work may organisations and individuals are already doing.  But more on this in a later article.

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Welcome to 2020!

For those interested in the topic of Performance Based Contracting (PBC) I wanted to provide my plans for the blog for 2020.

Firstly and most excitingly, in early February 2020 I will be releasing my first “podcast”.  This is a 45-minute introduction to Performance Based Contracting providing time poor readers a quick and simple way of getting to know the topic and the key features.  The only concern will be having to suffer my Australian accent; but hopefully it isn’t too bad for most of you!  From there, every two months I plan to release a new podcast looking in more depth at a particularly interesting topic within the field of Performance Based Contracting.

In addition to the podcast I will continue to release a number of articles on key topics.  Specifically, I intend to examine the following:

  1. Net Promoter Score performance measure
  2. Power-by-the-hour approaches
  3. Customer Experience (CX) approaches
  4. Applying the Information Pyramid to Performance Based Contracting
  5. Designing highly successful qualitative / subjective performance measures

Finally, together with some friends, I will continue to contribute articles to the Collaborative Contracting blog.

Of course if there is anything that you want me to specifically cover please don’t hesitate to ask as I am always keen to help people in their Performance Based Contracting journey and add to the wider community of practice.

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Happy 2019 Holidays to all the Performance Based Contracting (PBC) Blog Readers

To all my readers, while I hope you’ve enjoyed the content over the past 12 months, I hope each of you have an opportunity to have a break and a bit of downtime over the next few weeks.

At this joyous time of year, I am always grateful for the time I can spend with my friends and family, and I wish you all abundance, happiness, and peace in a New Year filled with hope.

Happy holidays!

Best Wishes
Andrew Jacopino

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Supply Chain Performance Measures

“There is an immeasurable distance between late and too late.”

Og Mandino

While driving to work the other day I listened to a discussion on the longest time listeners had waited for a parcel to arrive.  One caller said they were still waiting for their purchase from almost a year ago, to which the response from the radio hosts was “. . . looks like you waiting for a Christmas present . . . from 2018!”.

Given the festive season is almost upon us it got me thinking of one misunderstanding of single supply chain performance measures used by many delivery organisations to show us (the customer) how reliable they are in delivering their goods within the guaranteed delivery times.  One such performance measure is DIFOT, or Delivered In-Full, On-Time.  DIFOT is a relative measure in percentage, of the number of orders successfully delivered “in-full” (where there is more than 1 item) and “on-time” (based on the agreed delivery date at the time of purchase).

DIFOT is simple to use and easy to understand.  But what about our unfortunate caller whose order was not delivered in-full and on-time?  How do we track the performance of “failed” deliveries; that is deliveries that were not delivered?  Moreover, what if the only commercial consequence for the seller was DIFOT?  Is there any incentive for them to complete the late order?  While many of you may be thinking this is a negative opinion of many seller’s who want to ensure customer satisfaction, consider the following.

In 2017 Amazon shared some data on its Prime delivery services focused on two-day delivery with more than 5 billion items shipped worldwide with the two-day Prime delivery service.  So even if DIFOT was 99.9999% only for the Prime two-day delivery service this means that 5,000 deliveries we not delivered in full, on-time.  But what happens to these “failed deliveries”?  How to we track, and potentially incentivise, the delivery of these late orders?

One option is to include another performance measure representing the seller’s performance in quickly delivering the “failed deliveries”.  One such performance measure is Average Days Late which represents the average number of days for all failed deliveries after the agreed delivery date / time that customers are waiting for their late order.

Looking at the scenario below we can see that the majority of the deliveries were delivered in-full and on-time, and are captured by the first Key Performance Indicator (KPI).  However, there was one delivery that was not.  In this instance, the second KPI then addresses this failed delivery.  So combining the 2 performance measures, DIFOT and Average Days Late, results in a more accurate and representative picture of delivery performance compared to just DIFOT.

Figure 1 : Interaction between Supply Chain Performance Measures

The key takeaway here is that single performance measures typically do not accurately represent performance (see previous article, The Allure of a Single Measure).  Therefore, in designing our Performance Management Framework (PMF) we should ensure measurement of not only success, but also failure.  Since at the adage goes, “plan for failure, but hope for success”, although this festive season I hope all your wishes are delivered in-full and on-time!

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Collaborative Contracting . . . the blog

It seems that collaboration is everywhere nowadays.  Whether it is Ed Sheeran and Justin Bieber producing a number 1 single, designer Tommy Hilfiger and Formula 1 driver Lewis Hamilton delivering exclusive clothing lines to Apple putting CarPlay into a variety of cars.  Everyone seems to be doing collaborations, even businesses.  But are they all successful?  And if so, were they successful due to chance, a heroic individual, or by careful design?  And can we learn from this?

Given the relevance of collaboration to all us, both buyer and seller alike, a few of my colleagues (Jim Bergman, John Davies, Michael Frith and Greg Laxton) and I have started another blog, Collaborative Contracting, to try and help demystify this topic and provide practical, implementable solutions.  Importantly, this blog is not about marketing you a paid service or training course, getting a high page ranking or collecting email addresses for on-selling, and this includes comments (see the comments section below for rules on comments).  Instead, we are trying to create a not-for-profit Collaborative Contracting Community of Practice (CoP) to help socialise and advance this interesting and relevant commercial field.

While I will continue to write my PBC Blog (sorry!), you’ll also find me writing for Collaborative Contracting blog as well.  I hope to see you there in the future to learn and discuss this fascinating and evolving topic.

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