Thursday, March 6, 2008

Does your business have a canary?

Ronald J. Baker, in his book “Measure What Matters to Customers,” draws a parallel between leading indicators and the canaries used by coal miners to alert them to the presence of noxious gases. If the amount of carbon monoxide reached a heightened level in an underground cavern, the canaries would stop chirping, have trouble breathing, and in some instances even die. This early-warning system gave the miners the time they needed to evacuate the mine.

Baker suggests that, in addition to lagging measures (which follow changes in a business cycle) and coincident measures (which run in sync with a business cycle), firms should identify leading measures which anticipate changes in a business cycle.

Leading measures are harder to identify – whether financial or operational. Traditional reporting paradigms (P&L, Balance Sheet, and Statement of Cash Flows) focus primarily on lagging, financial measures of business performance. Identification of leading indicators requires development of a “theory of the business” in order to find those measures that are correlated with desired performance but can be measured prior to the results rather than afterwards.

Earlier this week, in an article in the Wall Street Journal about the slowdown in the construction industry, it was reported that “the American Institute of Architect’s monthly index of billings at architectural firms was down 14% in January from its peak in July. That means fewer construction projects will start this year, said AIA Chief Economist Kermit Baker.” In this example, the index of billings plays the role of the canary – an early-warning indicator about future negative performance. The challenge is: what do you do with this information? Can the AIA use this data to make operational adjustments which will increase billings and therefore increase future construction projects?

Does your business have a canary? What leading indicators do you use to predict future performance? How did you develop those indicators?

Mark Lorence bio – I’m a Director in the Strategy Practice at Palladium with 18 years of consulting experience in large-scale systems implementation, planning & budgeting solutions, and Balanced Scorecard implementations. My current area of focus is incorporating analytics into traditional Balanced Scorecard projects, integrating strategic planning and business planning processes, and augmenting these solutions with next-generation dashboards. I am a lifelong Pittsburgh Steelers fan now living in Boston and admit to a small amount of childish satisfaction from the results of this year’s Super Bowl.

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