Numbers drive the world of business: Revenue, profitability, production efficiency, production output, lost-time due to accidents, and a variety of other measures are commonplace. And leaders would be at a severe disadvantage without timely and accurate figures relating to all aspects of their business. Numeric literacy is a must!
However, in my experience few of the key numbers that leaders rely on regularly are what I would define as leading indicators. Most accounting and financial results—even clever ratios—are lagging indicators; they provide information about what has occurred in the past. Last quarter’s revenue is an example and it is generally reported some time into the subsequent quarter.
These numbers are important, but being able to define and track the crucial numbers that are leading indicators can provide leaders with significantly more insight into the future and allow them to make better decisions today and take action to achieve better results.
What are the leading indicators for your business?
Let’s start with a definition: Leading indicators are key numbers that drive future outcomes or results, and are those numbers that you can measure accurately today. Examples would include:
- If a result is cash-in-bank, a leading indicator could be the ratio of receivables to payables.
- If a result is sales revenue, a leading indicator could be the current value of opportunities in play. This may be enhanced by an understanding of the sales cycle duration and conversion rates by stage of the sales process.
- If a result is future production output, the leading indicator could be the cumulative production estimates of projects in hand, possibly weighted by project stage and likelihood.
In order to determine leading indicators, you should first decide what are the key outcomes or results your business is working toward. Are they revenue growth, market share, profitability, or some other outcome? These goals or targets are typically an output of the organization’s strategic planning process. Once the desired results are clear, it then becomes a matter of mapping or deconstructing the core processes in your business.
Deconstructing organizational goals
The exercise of deconstructing organizational goals involves a comprehensive cause-effect discussion. Starting with the organization goal, essential members of a team work backward to identify the factors or causes that influence that goal. For example, if revenue growth were a result, the cause-effect discussion could go something like this:
- The causes of revenue growth are (1) customer retention, (2) new customer acquisition, and (3) average customer-spend per year.
- In turn, the causes of customer retention are (1) the customer satisfaction score, and (2) on-time delivery percentages.
- …. and so on.
This type of analysis can be mapped in the form of a tree structure as shown below.
I have used this exercise with organizations in many industries, including energy producers, and service and supply companies. This procedure alone can generate important discussions about how core processes occur in any business, and it can uncover inaccurate assumptions that some leaders or team members may have about how things get done in the organization.
Measure and manage
Foundational to this topic is the ability to determine and to measure some objective, numerical value associated with a behavior or observation in the business. There may be situations in which you identify a key statistic that is not currently being measured. For instance, if it’s determined that revenue from existing customers is linked to customer satisfaction, and customer satisfaction is not currently being measured in any meaningful way by the organization, then a dilemma exists. In this case, management needs to evaluate the cost-benefit analysis of undertaking the process of collecting the data and establishing a customer satisfaction measurement.
Keep it simple
In determining key measures, it is important to keep it simple. The deconstruction exercise has the potential to identify a plethora of potential leading indicators, some of which may not be measurable using current mechanisms. At this stage, the goal is to narrow the list to a handful of measures that the leadership team will commit to collecting, monitoring, and reviewing regularly. Some important questions that leaders can ask to evaluate leading indicators include:
- Does the cost to gather the data needed to measure this leading indicator justify the value?
- Does this leading indicator link directly to one of our key business processes?
- Can this number be measured often and accurately? The best leading indicators are those that have daily or weekly updates and can be reviewed at weekly business execution meetings.
- Do we have proof or a history of the cause-effect relationship between the numbers being measured and the desired result?
If you answer “no” to some or all of these questions, then these numbers may be good candidates for removal from the list (or possibly managed at a team, functional or departmental level). Similarly, those measures remaining should be holistic in that at least one key number is in place for each of the critical functional areas within the business.
Once the short list is agreed, keep the handful of leading indicators visible. This is where business dashboarding software can help by displaying those key numbers with simple red-yellow-green color-coding based on agreed thresholds of health for each number. Also, assigning single-point accountability for each measure to one member of the leadership team drives further accuracy and performance for that area of the business.
The leader’s mandate
It is incumbent on business leaders to spend time thinking about the future. Sure, last quarter’s numbers may look good, but it is the future that leaders can influence through actions and decisions taken today. In an age of rapid change, it may be a stretch to say leaders can predict the future, but spending time to explore, define, and regularly make use of leading indicators can provide an element of predictive insight to support better direction, actions, and results.
