Do you know the best way to manage performance? It’s a combination of the insights you get from looking back (your lagging indicators) along with those that are forward-looking (leading indicators).
While these terms aren’t new, it’s important to understand them to set up your performance management system for success. I have found when working with businesses to establish their performance measurement systems and key performance indicators (KPIs) that there can be ambiguity around the terms leading and lagging indicators. Let’s delve into what these terms mean to help straighten that out.
Out the Windshield or the Rearview?
A simple way to differentiate leading indicators from lagging indicators is to think of your business as a car. When you are looking out the windshield, you are looking at what’s ahead of you—those are leading indicators.
Conversely, looking back at the road you just travelled, as you do in a rearview mirror, describes lagging indicators.
Typically, it is more challenging to define leading indicators. In business, examples of leading indicators might be consumer confidence or customer satisfaction. If you have higher customer satisfaction, it can help you predict future revenues. Happy customers tend to be repeat customers and are more likely to refer people to your business. Leading indicators are a bit of a crystal ball and are metrics that could help you predict the future. The term leading indicators originated from economics, where it is defined as a measurable factor that shifts prior to the economy following a trend. While leading indicators suggest conditions are favourable for a particular outcome, there is no guarantee.
Other leading indicators used in business include a new product pipeline, new market growth, and brand recognition. What they all have in common is they are things that can be monitored now to see if you will achieve your targets in the future. If your leading indicators aren’t aligned the way you need them to be, basically, if you’re not on the right track to achieve your goals, you can still make adjustments to the strategy.
Companies often have more trouble defining leading indicators. While they are an important part of your performance monitoring system, they represent what will likely happen in the future. Unfortunately, they aren’t always accurate.
A well-balanced performance-monitoring system also needs to include lagging indicators.
Lagging indicators are often the same as the metrics for your company’s goals and targets. They are often, but not always, very similar across businesses regardless of the industry. They tell you what happened, such as your revenue and profit numbers, and tend to be easy to identify and measure.
Lagging indicators are an important element in your performance management framework because they represent the undeniable truth. However, unlike with leading indicators, there is nothing you can do to change the outcomes. Lagging indicators are, by definition, final when you are reviewing them.
In some cases, companies focus too much on lagging indicators and miss important opportunities to influence outcomes by adjusting the actions that will impact the leading indicators. Since lagging indicators encourage a focus on outputs (a numeric measure about what happened) rather than outcomes (the desired result), some organizations can get hyper-focused on the end result without paying attention to what sacrifices and damage they could do along the way by “cheating” the system.
But cheating the system misses the point of measuring performance through indicators. By having the combo of leading and lagging indicators helps your team better understand performance and—very important—find ways to improve performance in the future.
Develop a Performance Framework
To find the right balance between leading and lagging indicators, you develop a performance framework. A performance framework articulates your strategic goals. There might be some financial goals such as we want to make this much money or this much profit, but you also want to look at your customers. Are we penetrating the market and increasing market share? There are also internal processes, service delivery, and product quality that are leading indicators for customer satisfaction. You should also have indicators for your employees, such as are you attracting the right people and recruiting them to create a quality product in the future. I assert that managing the performance of your organization is one of the (if not THE most important) things you should do as a leader. If you have a good framework that outlines the goals across the different parts of the organization (so the outcomes as well as the performance drivers and enablers), and then you measure them, you’ll have a balance between the leading and lagging indicators, which then helps you drive the performance of your organization.
For more information on leading and lagging indicators, you might be interested in my book: Key Performance Indicators for Dummies.