KPI based management for multilevel companies (Part 3)
Leading and Lagging indicators concept as an inherent part of KPI based management
It certainly is not enough just to create and use the set of indicators measuring such activities as financial results (effectiveness) and cash flow to manage the company in balanced way. Such indicators show only one part of operational activity, which appeared as a result of fulfillment of current plans and budgets.
It is usual for practice of companies that most of financial indicators of efficiency actually are derivative of the approved financial budgets, i.e. forming the structure of distribution of the resources, but not of processes. But for purposes of management it needs to fund KPIs, which could be influenced directly by managers. It is knows, that the only way for manager to influence on indicator is to know exactly all the chain of delegation (all the part of cascading) referring to this indicator, translating to the set of more and more detailed and specified tasks. For example, the return on assets as the major indicator (which is derivative of the budget of incomes and costs indicators and the balance of forecast) is usually controlled by the financial executive officer. Certainly, it needs to control all the chain of parent indicators to receive a precise value of this KPI. In this case the chain consists of: Profitability of earnings and asset turnover, which, in turn, depends on productivity of resources, success of realization of investments into development of the company and a stable market share.
Lagging indicators are mostly historical metrics; they are aimed to measure the performance of company’s past activities. For example, most of financial KPIs are actually lagging indicators. Managers are not able to receive up to date information from lagging indicators (reports might be received once quarter or even a year). That is why they are not able to monitor these processes directly. Lagging indicators present the performance of the overall system’s work and there are lots of factors that influence on them. These metrics show the results and effects of management actions that already have been applied.
Leading KPIs are the metrics that refer to the current and future effects. Oppositely to lagging indicators, leading ones are linked with manager’s decisions directly. After a decision is taken, it could be resulted in changing the performance of activity, that leading indicator show. Lagging indicators are needed to be used as a tool to manage the company’s future (which is actually one of the most important goals of the Balanced Scorecard concept).
It needs to be known that leading and lagging KPIs terms might be used by both strategic and operational management. As for strategic management, it uses those KPIs as elements of the strategic map. As for operational management, the current planning might use leading indicators of efficiency as a part of an operational cycle frameworks. Since the duration of operational cycles is usually from a week to a month, it is necessary to make special demands to periodicity of reports on leading KPI’s, because those indicators allow to measure the performance of process and actually refer to up to date problems of subsystems.
The map of the article
- Part 1: This part introduces the basic statements of KPI based management. Also it defines the term KPI;
- Part 2: BSC management system’s methodology;
- Part 3: Leading and Lagging indicators concept as an inherent part of KPI based management;
- Part 4: This part presents the basic criteria of what KPI to include in the map;
- Part 5: Cause and effect relations between KPIs;
- Part 6: The beginning of Cascading description: classification of indicators for management according to their importance
- Part 7: Conclusion of Cascading description: Indicative and Imperative KPIs
