Wednesday, July 16, 2008

The Numbers that Really Matter: Leading Versus Lagging Indicators

As someone who knows finance, I cannot tell you how widespread it is for businesses to look at the wrong data to determine how to make critical business decisions. For instance, if you look at the efficient market hypothesis you can see that past results are not indicative of future performance. After all, if that were true we would all be rich because we would bet on the future based on the past. I think we all understand this concept intuitively, but so few law firms actually put this into practice.

What professional service firms really need to understand is the difference between Leading and Lagging Indicators. So unless you want to drive your car by looking in the rear view mirror {I certainly won't be a passenger in your vehicle}, then I suggest you listen up!

Here is an example of Lagging Indicators: (Dumb Data)

Profit - This is lagging indicator of how you managed the cost of your revenues last year

Revenues -- This is a lagging indicator of what customers did last year and says nothing about the future.

Billable Hours -- This is a lagging indicator of what people did with their time last year. It is not predictive, and since you have to consider write-offs, learning curves, loss leadership, mentoring, etc, it is not even a useful tool to truly understand the past!

Write Offs -- This is a lagging indicator of customer dissatisfaction in the past year (Note: It is NOT a sign of satisfaction. . . by the time they are crossing out your line items, they are already pissed off!}

Attrition Rates - This is a lagging indicator of how happy/miserable your people were last year.

Here is an example of Leading Indicators: (Smart Data)

Employee Happiness Index: This is a leading indicator of this coming year's productivity, attrition rates, and customer satisfaction (because happy people make happy clients!)

Hand Written Card Index: This is the number of hand-written thank-you cards your firm got from clients this year. This is a leading indicator of revenue growth through referrals, increased wallet-share per client, and customer loyalty.

Accounts in Pursuit: This is the total sum value of clients that the firm considers to be leads or prospects. This is a leading indicator of gross revenues in 30-90 days.

These are just some examples and there are hundreds of each. There will be only a handful of Key Predictive Indicators that will matter the most to your business. Now, there is a strong tendency to discount or fail to value Leading Indicators at all. There is an easy explanation for the phenomenon: Leading Indicators are far more challenging to quantify that lagging indicators. Most organizations fail to even try because they believe that if they wait and just let the future become history then they can reduce the acquisition cost of the data and make decisions based on the Lagging Indicator data. That practice is not only laze, but a highly costly mistake. The ability to know the future is a power that can be leveraged to far exceed the cost of acquiring the data, not to mention the fact that with a little creativity getting "golden data" does not have to cost much at all!

An Exemplary Example: At Exemplar we have studied the best business models in the world and their best practices to get a sense of how we can do better. Southwest Airlines, for instance, understands that the Employee Happiness factor is key in their business. The CEO said "I only hire happy people" and to date it has paid off. They know (as we do) that happy employees make happy customers and happy customers make higher revenue and thus higher profit due to the increased productivity. You see, this one factor has a ripple effect through both the inside and outside of the organization. How, you ask, do you figure out your Employee Happiness Index? Well, it can be different for every organization. We have adopted a practice that I learned about by reading Ron Baker's book "The Firm of the Future". We are instituting the "HSD Button" program, called the "High Satisfaction Day Button". We wanted to know, on average, how happy our people were on an ongoing basis. The cost of doing surveys is too high and hard to normalize and quantify, so we needed something fast, simple, and effective. So, we are putting a small button on the computer screen desktop called "HSD", and at the end of every day before people sign off they are asked to think about whether they had a satisfying day, and if so they would press the button. You can see that everyone would use their own subjective standard to evaluate this and that is OK. The absolute number and standard is less important than data trends, spikes, and changes over time. Now, we have our heads around a Key Predictive Indicator for the business that will help you avoid problems before they become a part of your "history" and helps us to make profitable decisions because we know where we are headed. At Exemplar, we lead by looking forward to the future. Don't drive your car by looking out the rear view mirror. If your people found out that you were running your organization that way, they might jump ship! I certainly would!