Sunday, 19 February 2012

The Fallacy of Leading Indicators

In recent months we’ve noticed an increasing number of executives asking “how do I get leading indicators”? It seems that everyone is frustrated by the fact that lagging indicators only report history and what has happened. And in today’s turbulent environment – where past performance is only a weak indicator of future potential – historical data has become even less useful. Hence the search for the magic leading indicators…

The problem with this search is that it is a fool’s errand. There’s no such thing as a leading indicator. Let us illustrate the point. Often people claim that customer satisfaction is a leading indicator. If you satisfy customers today, they’ll come back tomorrow and buy again from you. And even if they don’t come back, if they are happy, they’ll tell their friends about your great product or service and encourage them to buy from you. So customer satisfaction is a leading indicator of future sales.

Let’s look at this from a different perspective – let’s think about the link between customer and employee satisfaction. Many executives would argue that happy employees lead to happy customers. If employees are happy, they work harder, deliver better service, look after the customers more – hence customers are happier. So employee satisfaction is a leading indicator – it indicates what future customer satisfaction might be. But then customer satisfaction is a lagging indicator – at least it is a lagging indicator with respect to employee satisfaction. And therein lies the rub – customer satisfaction is both a leading indicator (with regard to future sales) and a lagging indicator (with regard to employee satisfaction). How useful is a categorization framework that allows a single item – customer satisfaction – to be both a leading and a lagging indicator?

So what’s the answer? All the talk of leading and lagging indicators is meaningless, unless you consider the context. What really matters is the relationship between the measures – the performance model that shows how different dimensions of performance interact and impact one another. To ask the question – what leading indicators should I use is naïve. The question we have to ask is what performance model am I using to run this business? A good performance model illustrates the relationship between the different measures, allowing managers to understand how value is created through a network of interacting elements.

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