Leading and lagging indicators

Cause and effect is a well-established principle, even if we sometimes confuse causation and correlation (see divorce / margarine correlation).

For most companies, the main measures of performance are the usual suspects, revenue, profitability, and cash. We see this reflected in our clients, where the most common top level OKR is to ‘Increase Revenue’.

Revenue is a lagging indicator of business performance. In order to generate revenue, and revenue growth, we must influence the leading indicators of revenue generation.

Once we start to drill into the cause and effect chains, we see that revenue is connected via causal chains to dozens of leading indicators of revenue performance.

A simplified view of a single causal chain for revenue looks like this:

Revenue <- New Customer <- New Lead <- New Visitor <- Marketing Message

Lagging Indicator: Revenue

Leading indicators: Customers, Leads, Visitors, Marketing Message

Another example looking at revenue generation from existing customers:

Revenue <- Updated Contract <- New Project <- New Customer Need <- Account Review

Lagging Indicator: Revenue

Leading indicators: Contract, Project, Customer Need, Account Review

In both cases, even with these highly simplistic examples, it is clear to see that revenue performance is dependent on performance across multiple functions, with individual employees contributing at different stages of the causal chain.

New Business causal chain – departmental view:

Revenue <- SALES <- SALES DEVELOPMENT <- DIGITAL MARKETING <- MARKETING COMMS

Existing Customer causal chain – departmental view:

Revenue <- LEGAL <- SALES/PMO <- PMO/CUSTOMER SUCCESS < CUSTOMER SUCCESS

 

Setting goals to drive performance

Understanding that revenue, and profitability, and cash flows are lagging indicators, with several multi-layered dependencies is crucial when setting goals. From the analysis above, we see that in order to drive performance in lagging indicators such as revenue, profitability and cash flow, we must target the relevant leading indicators.

In the world of the Balanced Scorecard, leading indicators are referred to as Performance Drivers, and lagging indicators as Outcome Measures. These descriptive titles are useful as a reminder of the difference between leading and lagging indicators.

 

Causal Hierarchy

In the real world, we see that top level outcomes such as revenue is in fact supported by a large number of interlinked causal chains. This causal hierarchy is highly dynamic with significant interdependence within and across causal chains. Understanding that a chain is only as strong as its weakest link requires managers to understand the full breadth and depth of the causal hierarchy for whatever they’re responsible for.

 

Frameworks for managing complexity

Managing complex causal hierarchies can rapidly mushroom into a significant management head ache. However, this is the reality in which management frameworks such as the Balanced Scorecard, and Objectives and Key Results have flourished.

With OKRs, the causal chains, and a causal hierarchy emerges from the process of setting top-level OKRs and negotiating supporting OKRs throughout the organization. The aim is to achieve specific alignment between Objectives. For example:

Revenue Growth <- Customer Growth <- Increased Customer Satisfaction <- Improved UX

In the Balanced Scorecard approach, general causal chains are predefined to highlight causality between different BSC perspectives, e.g. as follows:

FINANCIAL <- CUSTOMER <- PROCESS <- LEARNING

With the BSC, we see that in order to drive process improvements, we need to educate our staff to make the required improvements. The process improvements drive increased customer opportunities, which in turn drive improved financial performance.

With OKRs, we are setting specific Objectives to achieve for each quarter. Knowing whether and how such Objectives map to the Balanced Scorecard perspectives can be a good sanity check.

 

Work In Progress

Working with leading and lagging indicators is always going to be a work in progress. Internal and external factors will change continuously to ensure that your causal hierarchy will always be shifting one way or another.

However, whether working towards longer term goals, or shorter term Objectives, using frameworks such as the Balanced Scorecard and OKRs can help to mitigate much of the complexity and ensure everyone is focused and aligned on the leading indicators or performance.