Leading and lagging indicators seem to create confusion for some people, yet with a clear understanding, it is easy to see explain how they work and help people think productively about how to create and use them.
In this article I want to explain how different types of leading indicators are needed and will occur in different circumstances. I will explain the questions I have been asking clients to help them understand what sort of leading indicators they are looking for. This will help you be much more explicit about what you want in a leading indicator. That will make it easier for you to design and choose the right leading indicators.
Understanding different types of leading indicator and their importance
I have already talked about the core difference between leading and lagging indicators in another blog (but I’ll repeat the short version here) . I have also talked about how leading indicators also depend on your perspective, so a lagging indicator for the sales team (signed contracts) might be a leading indicator for finance (booked revenue).
In the examples below I have identified ten different types of leading indicators that I have come across in my Strategic Balanced Scorecard consultancy work. Ten different types of leading indicator, that each require different ways to think about the problem of creating leading indicators.
I have also highlighted the question in the client’s mind when they are looking for that type of leading indicator. This “question in their mind” is most important: for a single lag indicator (or objective, or outcome) can have a whole host of different leading indicators depending upon what you are trying to predict, what you are worried about, or what you want to influence. If you omit this question, you have no criteria for choosing an appropriate leading indicator and knowing whether you have one that is useful for the situation you are addressing.
Asking the right questions about leading indicators
It is really important you ask the right questions about what you want to achieve with your leading indicator. There are basically three questions:
- What is this about? What is the component, system or outcome you are interested in?
- What is lag event you are interested in predicting (and what is the lag indicator of that event)?
- What aspect of potential performance are you interested in measuring? What leading aspect are you trying to measure?
In summary, what sort of decision, about what, do you want to understand and predict?
So often we see articles about leading indicators, but they do not even think about this third question. In fact some even don’t ask the second question about the type of lagging indicator they are looking for.
If you do not know why you are trying to introduce a leading indicator and what decisions you are going to use it to inform, then you are wasting your own and everyone else’s time. You will just add to the large volume of indicators out there.
This follows our basic approach to measurement; that is to be clear what you are trying to achieve and consider what would be useful to measure, BEFORE you even start to think about measures. “Objectives before measures”
Let us look at the most common sorts of situations, and different types of leading indicators, so we can unpick this further.
1) Simple operational leading indicators
In many cases there are leading indicators associated with the part of the operation you are looking at. These leading indicators are within the component you are interested in. The question here is “How do we know this component is working or about to go wrong?”
There are plenty of examples of this sort of leading indicator. When you go to a doctor, they might test your heart rate, blood pressure, take blood tests for cholesterol or other problems. When you car goes in for a service they look at the brakes and oil or cylinder pressures to identify potential problems. In looking at the person (or the car) there are leading indicators of problems available.
There are simple versions in call centres. A leading indicator of call performance is the number of staff who turn up. Take three people out of a 20 person call centre and you will have delays answering calls.
Take the simple example of a pump in a water pumping station. This is a good example of a simple leading indicator in asset management. You are interested in leading indicators of failure. The lagging indicator (actually measure) is whether it has failed or not. What might be leading indicators of failure of this pump (or similar assets)? Here are just a few:
- How old is it?
- Has it being maintained to schedule?
- Are the bearings making a noise?
- Has the oil being changed?
- How old is it relative to the mean time between failures for this type of pump?
- Has it been pumping material that would lead it to be more likely to fail (eg a more corrosive substance or grit in the liquid)?
Any of these could be used as an indication or predictor of failure.
In all these cases the leading indicators are within the component, assets or people. However, whilst useful, especially if aggregated across a whole organisation’s asset class of pumps, it is a narrow view of the asset class pumps and their immediate maintenance or failure. It is not looking at the system or process in which it is sitting.
2) Leading indicators across and within a process
I frequently use the example of leading indicators that depend upon your perspective. To the finance team, who are concerned with income collection their leading indicators are invoices sent to clients. To the part of the team interested in paying suppliers, they are interested in budgeted expenditure and commitments to suppliers, (if doing commitment accounting) of invoices received.
The sales team are looking at leading indicators of sales and perhaps bids submitted, meetings with potential clients and opportunities identified. They are looking at their pipeline of sales and the probability of winning particular opportunities. To the sales team, a signed contract is a lag indicator of success. However, finance would see this as a leading indicator as no good or services have been yet exchanged and no invoices have been submitted. They certainly cannot book it to the accounts yet. The lag indicator of sales success, is a leading indicator of finance.
The question being asked is, “What is happening earlier in the process (or processes) , that will allow me to predict activity, results etc.?” The leading indicator is designed to understand what is happening earlier in the process, that will affect a later stage of the process. In strategic balanced scorecard terms, these leading indicators are operating along the process perspective.
In the pump example, cuts in maintenance budgets (earlier in the process) are probably a predictor and leading indicator of problems and failed components, stored up later.
Another leading indicator occurs where there is systematic failure being propagated along a system. For example, if you make fibreglass aircraft components you create a mould from which the components are made. One organisation I came across had been skimping on the mould and therefore had to spend massive amounts later in the process fixing problems and flaws with the moulded components. The error was propagating along the system and each stage was magnifying the problem. The leading indicator of quality was actually the amount of money and care that went into the original moulding process.
In all these cases, the leading indicators are earlier in the process; in some cases earlier in someone else’s process. In effect you are looking along the process for leading indicators of lagging effects at the end of the process.
3) Leading indicators across a system
Sometimes you are trying to look for leading indicators of system failure. You need to look at how the whole system operates. This is wider than the organisation’s processes. It encompanses all their activities and the activities of the markets and environment in which they operate.
The pump example is a good example of a single point that is actually part of a whole system. For instance, if this is waste water and sewerage, then many other components earlier in the system might have an effect on the pump’s failure. In this example I am separating the operating and management processes of the water company from the performance of the infrastructure and water system they provide, and how those system components work together. For instance, are the filters earlier in the process working properly and keeping sludge and detritus out of the pumps? Is the water clean enough to be pumped? Is the pump being over loaded or having to run for long periods, because of flooding caused earlier in the process? What is the whole system doing to the pump’s performance and reliability?
We can take a wider view of the outcomes for the customers of the pumps and components in their clean water system? What are leading indicators of water quality or interruptions to supply for the customer? This goes right back to the sources of water (bore holes or reservoirs) and the whole water system that moves the water to the customer, the state of the pipes and whether they are prone to leaking or bursting. Each of these components is subject to maintenance and asset replacement processes as well as influencing the other components and water quality further down the system.
There are leading indicators within the system and within the management and operating processes that affect the system. In strategic balanced scorecard terms, these leading indicators are operating along the system as defined and scoped in the strategy map.
You are interested in changes to the system, not just the processes.
4) Financial and activity driver indicators
This next example, is sometimes asked for but rarely what the clients are really after.
A very common approach to leading indicators is to create financial or activity driver models and look for the leading indicators that drive later values. A simple example of this is from the e-commerce market:
- Paid adverts…
- Leads to click-throughs to landing pages…
- Leads to website activity…
- Leads to sign-ups…
- Leads to sales and revenue.
In theory, by increasing the click-through rates, or improving the quality of landing pages or increasing sign-ups, this will lead to revenues.
Likewise profitability is a function of margin on a product x sales, less overheads. So increasing turnover, increasing the sales price or reducing the direct costs, all increase the margin. Lowering overheads whilst maintaining the others, will increase overall profits.
All these are simple models of what drives an end outcome. the drivers can be activity (such as click-through rates) or financial levers (such as price and sales volume). These all work as leading indicators of eventual margin and profit.
In any balanced scorecard of any generation, you need these basic models of performance to understand what is going on. These leading indicators of finances and activity are necessary and useful. However, they rarely address the deeper influences in an organisation that actually drive performance, increase sales, create ideas to improve overheads, margins or click-through rates.
In our experience, these are useful, but relatively basic. If a client is asking for leading indicators, they usually want something more sophisticated and smarter than this.
5) Leading indicators of organisational change
When you are interested in the effect of the mechanisms of change you are using, you are using a completely different dimension to leading indicators. The emphasis here is on, “How do we know our strategy or change programme is having an effect?”
First, let us make some statements about our approach. Given:
- The balanced scorecard approach of Norton & Kaplan, is probably the most common place where discussion of leading and lagging indicators are discussed,
- The approach is about strategy and change and executing strategy…
…and you are genuinely trying to implement a strategic balanced scorecard that is about implementing strategy and change …this is where a lot of leading and lagging indicator conversations get started.
So, in this case we are looking for leading indicators that our planned changes will occur and result in improvements to customers outcomes or financial outcomes. There are plenty of these:
- Improvements in processes being implemented
- Change projects on track
- Improvements in capability
- Increased knowledge about the customer
- Training courses or skill profiles improving
- Extent of culture change.
- Progress with culture change initiatives
- How well the strategy has been socialised.
- Whether staff are noticing changes in manager’s behaviour.
Each of these leading indicators could be attached to a specific part of the strategy map structure and the cause and effect model that is built up when the strategy map is developed. Each could then be carried across to the accompanying scorecard (Balanced Scorecard) so that the change could be tracked. In strategic balanced scorecard terms, these indicators are operating vertically through strategic themes across the perspectives of the strategy map.
In essence, the lagging indicators of change, (are we getting the results we expected from our strategy) are in the top half of the strategy map, in the customer and financial perspectives. These leading indicators are in lower parts of the strategy map covering the process and learning and growth perspectives. They are also in the initiatives and change projects that are designed to implement the strategy.
It is obvious, but I’ll point it out: different organisations, even with the same external outcomes or objectives, will have quite different performance gaps and objectives. They will choose quite different strategies, philosophies or mechanisms of change. Each will therefore needs different sets of leading indicators, for strategy and organisational change, particular to their strategy and ambitions. This is why, we do not believe in cookie cutter standard sets of measures for strategic balanced scorecards. Sure, there will be some overlap, but each need choosing for their particular circumstance.
Copying someone else’s leading indicators of strategy and change will only be useful if you also copy their strategy, philosophy and performance gaps. (And I assume you are not unthinkingly indulging in copy cat strategy). Implement someone else’s strategy alongside their leading indicators of their strategy and you will only end up knowing how unsuccessful their strategy would have been in your organisation, were you to implement it.
Yes these changes will affect processes, the systems and even point components. However the emphasis is on tracking the leading indicators of the change being applied, and then having an effect, and so improving (later) the capability of the organisation, the processes and ultimately the results for the customers, beneficiaries and finances.
6) Leading indicators of customer objectives or outcomes
Now let us change perspective and look at things from the customers’ perspective (or in the case of a charity, the beneficiary’s perspective).
Most models assume that doing things in the organisation results in objectives or outcomes for the customer or beneficiary. In fact it is quite common to see leading indicators associated with processes, the system and strategy or change that result in customer objectives or outcomes.
However, reality is not that simple.
In many cases the organisation is affecting only a part of that customer’s activities or processes. For instance, is buying a smart phone really improving that client’s communication, or increasing their network of friends, or just facilitating it? What else would that client need to better use that smart phone? If a charity helps someone who is homeless with a bed for the night and food, that is not immediately getting them back to work, or solving their longer term reasons for being on the streets. However, it may be a start. The customers and beneficiaries, themselves go through processes. The organisation may help them along.
So, you may also want to employ leading indicators of the customer’s or beneficiary’s progress towards an end outcome (Not just what company offered them or pushed them towards). There might be leading indicators of continued smart phone use, or leading indicators of whether someone stays off the streets and in employment.
Of course, this is only the outcome part of the leading indicator question. The other part is your ‘strategy for change’ and your ‘theory of change. Both of these are explained in this post on outcome thinking and this paper on outcome thinking and the underlying models.
In fourth generation strategic balanced scorecard terms, these leading indicators are in the customer perspective. In the case of charities, the leading indicators are in the beneficiary perspectives. How you change those outcomes is embedded in the links between objectives and the cause and effect model.
7) External leading indicators or External Predictive Indicators (EPIs)
I have written about external leading indicators or rather External Predictive Indicators (EPIs) elsewhere. However, just to summarise, they are indicators in the external environment that things are changing that might affect your strategy or how you work.
For instance, competitor moves, legislation changes affecting your industry or economic changes.
In fourth generation strategic balanced scorecard terms, these leading indicators are in the external perspective, informing the strategic discussions and asking questions about whether the strategy needs to be refined or changed.
8) Leading indicators of demand
Leading indicators of demand are really only a special version of either system or process leading indicators. However, they are such a common and important leading indicator of performance and their consequences for lag indicators, that they are worthy of separate consideration.
Typical leading indicators of demand are usually external and might be market activity, in a sales context, or a sales campaign. Demand can be generated internally, say anticipating extra work for finance during year-end or when a change of working practices affects a call centre. In a call centre it might be product notices recently sent out or an expected demand when a particular offer matures or a problem has been identified. In a water company, rainfall or drought will affect water consumptions and the volume of water entering the drains. In a sales company, an advertising programme or product launch should precede a jump in sales and deliveries.
What can be quite subtle here is that the external demand, can itself have leading indicators that it is about to rise. For instance, increased social media conversations about a product, or an unexpected celebrity endorsement, might be a pre-cursor to a jump in sales. The question is where in the customer process and conversation, do you want to place your leading indicators of demand?
9)Leading indicators of risk
Some consultancies like to add “indicators of risk or “Key Risk Indicators” to their balanced scorecards. I have written elsewhere that simply adding key risk indicators is a simplistic and flawed approach. I devoted a whole chapter of “Strategy mapping for learning organisations” to the subject of thoughtfully considering risk and eventually using indicators and measures of aspects of risk to your strategy maps and strategic balanced scorecard. Some of those insights about strategic balanced scorecards and risk are also here.
Lag indicators of risk are really easy to find.
- “We have just had our reputation ruined by appearing on the front page of a newspaper with a profits warning”.
- “The office has just burnt down.”
- “We had a loss of primary containment (LOPC) when gas escaped in the oil refinery and three people were killed”.
How do you develop a leading indicators of risk?
First you need to think about the risk mitigation and management approach. This is a simple five stage test of your management of risks:
- What is the risk?
- Do we know whether the risk is occurring?
- How do we prevent it affecting us?
- How do we limit the consequences of it affecting us?
- How do we recover if all else fails?
So, a leading indicator of risk is one that tells you that the risk is starting to manifest itself, or occurring in the market, the environment or the operations of the business or organisation. For example,
- If the risk is oil price rises, then what political disturbances or changes in a country might precede potential wars and loss of oil?
- If the risk is the computer centre burning down, what fire alarm or smoke detector systems do we have in place?
- If the risk if flooding to properties from excessive rainfall, what weather conditions over a period of time might, or drain conditions, might lead to those circumstances?
In each of these situations, there are leading indicators of risk that complement the lagging indicator that the risk has manifested.
Actually there are subtle variations on leading indicators depending on where you are in this risk mitigation process. For instance, the extent of your protection against fire is a leading indicator or risk for stage two of the process. In the oil and gas industry, analysis of incidents that could have led to loss of primary containment, are a great source of potential mitigation actions and a leading indicator of potential catastrophic loss of primary containment.
In our fourth generation strategic balanced scorecards, these leading indicators of risk are first classified into risk categories and areas, as well as levels (external, strategic, operational) and then we identify those indicators which would usefully inform the decision-making conversations around those aspects.
10)Leading indicators of the quality of decision-making
The final group of leading indicators is almost a set of leading indicators about leading indicators. Meta-leading indicators if you like.
This final set is about the process and quality of decision-making that goes on within the organisation. There is clear evidence that time spent making good decisions is rewarded in more effective implementation. This is about how decisions are identified, framed, made, decided (committed to) acted on and learnt from. (A decision-making model that I talk about elsewhere).
The quality of decision-making in an organisation will dramatically affects its ability to plan, communicate and execute its strategy and its operations. It will affect how people behave and work together. It will be deeply rooted in the culture of the organisation.
This is about how decisions are made about strategy, culture, projects, initiatives, what customers to address, what products to develop, which partners to work with, what capital investments to make. This can be about the strategy for the organisation or the strategy for a division of group, or their tactical choices. It transcends all topics and meetings.
These leading indicators are about the quality of thinking, analysis, conversation, rigour, information, evidence and thoughts that go into the decisions. These are about the quality of the commitment to action and the quality of they way these commitments are followed up and executed.
Most importantly this is about the quality of learning in the organisation: how they learn from their decisions.
Vary rarely do organisations explicitly look at their decision-making processes, particularly the front end, and think, “how is this leading to effective decisions and action”. Yet, ironically, most executives realise and know that decisions made well, are executed well.
Ironically, the last category is, in many ways , the most important category of leading indicator: the leading indicators of the quality of the decisions, their implementation and how they are learnt from.
In conclusions, Leading indicators can take various forms
In summary, leading indicators take various forms, depending upon the question you are asking, the event you are trying to predict and the activities you are trying to influence.
Please, if you are trying to develop leading indicators, then first ask questions:
- “What sorts of situations and we trying to measure the leading attributes of?”
- “What types of decisions are we interested in informing?”
- “Why are we looking for leading indicators and what are we going to do with them when we have them?”
How do we know this stuff? We have been doing this strategic balanced scorecard consultancy for over 20 years, in all sorts of industries, in many countries, for clients from charities and government agencies to large corporates. We get asked about leading indicators from a variety of clients wanting quite different things. We believe, and I am sure you will agree, that it is vital to understand the question, BEFORE you try to answer it.
If you are genuinely interested in making sensible decisions about the right sort of leading indicators for your organisation, and having a set that are useful and that inform your team’s decisions, then get in touch.