The terms “leading indicator” and “lagging indicator” have become standard terminology in performance measurement and management. But the distinction between the two can sometimes be a bit opaque – some indicators are a bit of both, for instance.
Managers really need to understand the difference between the two and ensure they have both types of metrics in place if they’re to build an accurate understanding of performance.
The 30-second definition
The best way to manage performance is to merge the insights from backward-looking indicators (your lagging indicators) with more forward-looking insights and predictions (your leading indicators).
Therein lies the main difference between the two:
- A leading indicator looks forward at future outcomes and events.
- A lagging indicator looks back at whether the intended result was achieved.
Imagine your business is a car. Leading indicators look forwards, through the windshield, at the road ahead. Lagging indicators look backwards, through the rear window, at the road you’ve already travelled.
A financial indicator like revenue, for example, is a lagging indicator, in that it tells you about what has already happened. Strictly speaking, last year’s revenue doesn’t predict future revenue (although it has been used to do just that by many businesses in the past). But an indicator like customer satisfaction does point to future revenue – because satisfied customers are more likely to repurchase and tell their friends about your company. Customer satisfaction, therefore, is a leading indicator.
Delving into leading indicators
Leading indicators are about trying to predict the future. The term “leading indicator” originated in economics, where it’s defined as a measurable economic factor that changes before the economy starts to follow a particular pattern or trend. The number of mortgage defaults, for example, can predict negative changes in the economy.
In business, brand recognition, new product pipeline, growth in new markets or sales channels, are all examples of forward-looking indicators, pointing to trends that can predict future performance. Customer satisfaction can be an indicator for customer loyalty (and, in turn, future revenue), while employee satisfaction can be an indicator for staff retention (and, in turn, performance and productivity).
Leading indicators are important for building a broad understanding of performance because they provide information on likely future outcomes. But they aren’t perfect. For one thing, they aren’t always accurate. Many of us were perfectly satisfied with our old Nokia mobile phones, for example, but we still switched to Apple or Samsung when smart phones were released! Therefore, think of leading indicators as what might happen, not what definitely will happen.
In addition, leading indicators are harder to identify than lagging indicators (which tend to be pretty standard across industries). Leading indicators are much more likely to be unique to your company, which makes them harder to build, measure and benchmark.
Understanding lagging indicators
Lagging indicators tell you about what has already happened, with common examples being revenue, profit and revenue growth. They’re typically easy to identify, measure and compare against elsewhere in your industry, which makes lagging indicators very useful.
However, the obvious downside of backward-looking indicators is they may provide insights too late to do anything about it. By the time you find out that half your customers have defected to the competition, it’s already too late to stop them. Even if it’s not too late, the lagging indicator is probably not telling you why this trend is happening and what you can do to stop it.
Another downside is that lagging indicators encourage a focus on outputs (a number-based measure of what has happened), rather than outcomes (what we wanted to achieve). One example of this will be familiar to anyone who regularly travels by train in the UK. As a lagging indicator, the train operator measures how many trains arrive at their final destination on time. To ensure it hits this indicator, the operator regularly amends the service, skipping smaller stations along the route to arrive at its final station on time. This negatively impacts arguably more important measures like customer satisfaction.
This focus on hitting lagging indicators (and how easy it can be to cheat the system to meet them), means lagging indicators are often prioritised over leading indicators – even when the leading indicators would be much more useful for understanding and improving performance.
Getting the most out of leading and lagging indicators
The purpose of measuring performance through indicators is to really understand performance and identify ways to improve performance in future. To do this properly, you need both types of indicators.
It’s also worth noting some indicators can be both leading and lagging. For example, being able to recruit the best talent could be considered a lagging indicator for HR (as in, has HR put the right systems and processes in place to recruit the right people?), yet it’s a leading indicator for the company as a whole, because it should translate into better business performance in the future.
That’s why, when I work with a client to define their strategy, we create what’s called a “plan on a page”. This breaks down the company strategy into several key areas or “panels” – including a finance panel, a customer panel and a resources panel – and sets out the desired outcomes for each area. By focusing on outcomes (and the actions/inputs that will go into achieving those outcomes), you can identify the right combination of leading and lagging indicators to create a detailed picture of performance.
Where to go from here
If you would like to know more about KPIs and measuring performance, check out my articles on:
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