Just as you can't drive to work with your eyes only on the rearview mirror, you can't drive your business forward by focusing on the past. Yet that's what you're doing if you're relying solely on lagging indicators such as revenue, profit, or Cost of Goods Sold (CoGS) to manage your organization's performance. These factors are important, but once they're calculated, it's too late to impact them. What you need are good leading indicators that allow you to spot trends and see issues before they balloon into real problems.
Leading vs. Lagging Indicators
Leading indicators are early predictors of sales and profit, and in combination with lagging indicators, they give you a holistic view of your company's performance. Lagging indicators such as revenue, sales, expenses, and inventory turnover help you understand whether or not certain objectives have been met. They can depict trends when periods are compared, but by then, you're too late to profit from the early discovery of the trend. Lagging indicators are calculated at the end of a period (month, quarter, etc.), so you won't know whether or not a goal has been met until nearly the end of the period. Even if you run some ad-hoc reports throughout the period, you likely can't get to the root of a problem in time to impact the outcome. Chances are, things were going wrong long before the lagging indicator on your dashboard turned yellow.
On the other hand, leading indicators pinpoint the source of future problems and help you predict whether or not the target values for your lagging indicators will be met. Leading indicators enable your company to avoid problems and operate more cost-effectively. For example, rather than tracking product returns (a lagging indicator), reporting a 90-day customer complaint trend allows you to fix problems earlier and less expensively. Drilling down into the complaints themselves, you might discover that a particular product has a defect that your quality assurance team didn't catch. Removing the product from your shelves may save you a lot of trouble in the long-run, reducing complaints (and the negative feelings your customers may be starting to harbor toward you) as well as the cost of returns (returns aren't free - they cost retailers nearly $14 billion a year).
Tracking receivables turnover (a leading indicator) enables the company to better manage its cash (a lagging indicator). How fast accounts receivable are collected is an important indicator of your company's financial and operational performance. Spotting issues with this leading indicator may lead your finance team to institute an accounts receivable allowance to prevent cashflow issues.
Want more examples of Leading & Lagging Indicators?
- Here's an interesting article on what leading indicators Research in Motion (RIMM / Blackberry) should be looking at to determine the company's future, including US Market Share as a weather vane for global market share; and New Subscribers as a predictor of future financial performance.
- Revenue forecasts are a predictor of future revenue. So, your Q4 forecast (leading) should predict your Q4 revenue (lagging).
- Customer satisfaction can be a leading indicator for market share; generally, happy customers mean your products & services perform and are perceived well, which can lead to increased market share. But customer satisfaction may also be a lagging indicator of customer service if it's based on survey data. If it's your policy to send customer satisfaction surveys after every customer support interaction, responses may be biased by that most recent interaction with your company and may not actually have any effect on your market share -- these two metrics may end up totally uncorrelated.
Leading indicators are difficult to get right the first time. As you can see in the last example, you may determine a leading indicator that makes perfect sense, but in reality is not strongly correlated with a corporate goal. A thorough understanding of key business drivers is necessary to arrive at the correct leading indicators, and this is something that often takes time and testing to get right.
Since the real value of business intelligence is getting questions answered and being able to anticipate opportunities for growth, companies need to be more forward-looking. Scorecards and dashboards are designed to help you make better decisions, but only if the right performance metrics are in place. If your KPIs are only giving you glimpses into the past, it's time to revise them! It may take time, but hey, you've got 4 months to get 2012 off on the right foot!