Thursday, September 11, 2014

Leading Indicator vs. Lagging Indicator

Any individual indicator can be a lead or lag indicator depending upon the context and the explanatory model chosen.

As Drucker well pointed out: “You can only manage what you're measured.” Benchmarking and measuring are both science and art. There are many practical metrics and KPIs, but not every metric is created equal. The concept of leading and lagging indicators, as applied to the Balanced Scorecard, relies on an understanding of the cause-effect relationships between KPIs in the different perspectives. But what’re the differences between leading indicators vs. lagging indicators?



Any individual indicator can be a lead or lag indicator depending upon the context and the explanatory model chosen. Have always looked at a Lag Measure as the method for measuring the outcome and the Lead Measure as the bet you make. A simple question to ask: Does the indicator allow you to take action prior to having a bad result? If the answer is yes, it is a lead indicator. If it is no, it is a lag indicator. An indicator can be a lead for one person and a lag for another.

Financial results as ‘lag indicators”: In any time period, when evaluating the KPIs, the financial results are seen as the result of activities in prior periods. That's why the financial KPIs are "lag indicators". Financial results (the outcomes required by shareholders) depend upon customer satisfaction measured in different ways. Market share usually, (but not always) is related to revenue and profitability.

Process KPIs as “current indicators” or lead indicators. In process management, KPIs are seen to have a direct impact on customer satisfaction with a slight lag on market share and revenues. Today's process KPIs are usually (but not always) seen as "current indicators." Customer satisfaction is dependent upon a large number of internal business processes working effectively and efficiently. Procurement, production, logistics, marketing and sales processes need to work to produce the product or service demanded by the customer at a customer-value proposition selected by the organization. Process measures are therefore considered lead indicators of customer satisfaction. 

Learning and growth KPIs as “lead indicators”: Good process results depend upon a number of things included in the learning & growth perspective. Well trained and happy staffs are needed to make the processes work. Investment in new IT systems provides new capabilities and competencies (such as customer analytics and effective process control). Investments in leadership training affect the corporate culture and values, especially on innovation and empowerment. The Learning & Growth perspective is where businesses build institutional capacity and capabilities. These are longer-term investments which take multiple periods to have an effect on the financial KPIs. That why they are seen as "lead indicators." 

The lag and lead indicator concepts "warn" businesses that there is a multitude of relationships between KPIs. Initially, in the absence of historical data, you hypothesize the cause-effect relationships between KPIs in the different perspectives, and then you can test the validity of the hypothesized relationships as you gather evidence. And establishing the cause-effect relationships between KPIs is an important outcome of developing the Strategy Map (and the Strategic Themes within the Strategy Map). While there is (or should be) a cause and effect relationship between objectives and the associated measures; the lag and lead measures applies to individual objectives and not the cause and effect relationship between objectives. They are often useful for unpicking parts of the relationships that are described between objectives in parts of a strategy map. 

What tends to happen is that performance driver models are often dominated by measures that, in scorecard terms, fall into the same perspective or a very limited view of perspectives, such as the strongly financial or operational measures. By clarifying the concepts such as leading indicator and lagging indicator, organizations can develop strategy map, execute and measure more holistically and effectively.







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