Knowing the Difference Between Leading and Lagging Indicators
If you are like most leaders, the primary metrics that you use to set goals and to manage your business come from your income statement and balance sheet. Examples most often discussed are sales, cost of goods sold, gross margin, overhead, labor costs, profit, receivables, inventory, work in process, payables and cash. While these are measures you need to monitor, they are all lagging indicators. They are results from decisions and actions taken in the past, the scorecard you use to measure the success of those actions and decisions. The problem with trying to use those measurements to manage the business is that they are after the fact. While there is some benefit to using lagging information, it does not tell you why your results are the way they are. It is also too late to change the outcome. It is the equivalent of trying to drive your car forward by watching your rearview mirror.
Leading vs. Lagging Indicators
Your primary focus should be geared to key performance indicators, the leading measures that influence the end results. By choosing the right leading indicators you can help your team improve the lagging indicators. This approach can be problematic for leaders for three reasons. First, while all numbers on your balance sheet and income statement are lagging indicators, other measures can be leading or lagging depending on what you are using them for. For example, percentage of “A Players” can be a lagging indicator when measuring effectiveness of recruiting and onboarding processes, leadership effectiveness, and how well an employee is performing. However, it is a leading indicator in terms of customer loyalty, labor efficiency ratio, and other such measures. So it is important to really isolate what you are trying to improve.
Evaluating the Most Important Leading Indicators
The second issue is how to figure out which measures require the most attention. Every business is a compilation of processes that are composed of various inputs and outputs and various decision points. At each point, when something occurs or does not occur, it influences future outcome, and a potential for measurement occurs. If your company is like many other businesses, your processes may not be well defined, which is a huge leaky bucket. You also may not be clear on how each point in the process affects the overall organization.
I recently met with the CEO of a company that manufactures products for the construction industry. He was very focused on building up his sales and marketing team. Sales in the company had been hovering around $10 million for the last 3 years. When I dug deeper I learned that his company had proposed over $150 million in deals during the previous 12 months. I asked if this was a recurring problem, and the answer was yes. So his close ratio had consistently been less than 7%. My next question to the CEO was why he lost those deals. He was not sure, but it sounded like their products were not meeting the requirements of the marketplace. How was increasing the size of the sales force and improving the marketing department going to address that? He really needed to focus on close ratio and understanding what it was going to take to increase close ratio before doubling the size of his sales force and spending a bunch of money on marketing.
Measuring Leading Indicators
The third issue is the measurement itself. While there are usually systems and processes in place to compile your financial statements, many small and midmarket companies do not have measurements for their processes in place. As a result, there is uncertainty as to how to get the information you need and whether it will be accurate.
The bottom line is that what gets measured gets done. You do not want to measure too many things. If you cannot automate, it is important have the people responsible for the outcome or the step in the process to report on the measure daily. If you do not measure it, it will not improve. Many of my clients collect information in Google Docs. While this is less than ideal, it works.
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