Using Lead and Lag Measures to Communicate,
Motivate, and Evaluate

Chapter 2

 Chapter Outline

  1. Cost Management Challenges - There are three questions addressed in this chapter.
    1. How do cost managers use their understanding of current operations to predict future outcomes?
    2. How do cost managers predict the cost and performance of new products and services?
    3. How do cost managers combine measures of cost and performance to provide an overall picture of organizational performance?
       
  2. Learning Objectives - This chapter has three learning objectives.
    1. The chapter facilitates understanding of the use of lead and lag indicators to measure performance
    2. It teaches how to use target-costing analysis to "design-in" performance and cost
    3. Chapter 2 explains the importance of lead indicators and casual relationships in building a Balanced Scorecard for Communication, motivation, and evaluation.
       
  3. Eight broad management decisions were introduced in Chapter 1. They are:
    1. An organization's long-term strategy must be chosen:
    2. The scale of the organization and the scope of operations must be determined:
    3. The use of resources must be planned and organized in a way that maximizes the efficiency of operations;
    4. Plans and organizational change must be implemented;
    5. Results must be measured and reported;
    6. Individuals and sub-units in the organization must be motivated and then evaluated;
    7. Plans and results must be communicated to appropriate individuals and sub-units; and
    8. Decision making and improvement initiatives must be evaluated. 

      The first four of these decisions were presented and discussed in Chapter 1. Chapter 2 presents and discusses the remaining four management decisions in the context of lead and lag indicators, target costing, and the balanced scorecard.

  4. Lead indicators are performance measures of early value-chain activities.
    1. Lead indicators predict outcomes of value-chain operations that occur in the future.
    2. Lead indicators of current successes can be used as predictors of future successes.
    3. Lead indicators are used to identify future financial and nonfinancial outcomes to guide management decision making.
    4. There are three major types of lead indicators, which are discussed in more detail below, They are measures of (1) organizational teaming and growth; (2) business and process efficiency; and (3) customer satisfaction and loyalty.
    5. Lag indicators measure final outcomes of management plans. Though lag 'indicators are useful for evaluation of financial results (e.g., profitability), lead indicators are the measures needed to ascertain that profit outcomes occur as expected.
    6. Lead and lag indicators are related to each other. Lead indicators that are performance measures at one stage of an organization's value chain may be lag indicators in another stage of the value chain. For instance, a lead indicator may be customer satisfaction for an existing product. If management decides that customer satisfaction is lower than desired, then this may become a lag 'indicator for improving the production process. This change will, in turn, result in a lead indicator measuring customer satisfaction again.
  5. One of three key types of lead indicators is measurement of organizational teaming and growth. Organizations grow through the teaming and growth of employees. When employees learn, there should be increased customer satisfaction, ability to meet future needs, and new sales may result. Employee teaming can be obtained and monitored in four ways.
    1. Training and education. Training can be developed in-house or can be brought to an organization. Employees may also be reimbursed for training and education obtained from external sources.
    2. Reward employee innovation. New products and services are often the result of employee innovation. Progressive managers encourage employees to share knowledge and ideas via team decision making.
    3. Reward and measure opportunities for improvements. Employee suggestions should be encouraged.
    4. Measure the amount of time needed to develop new products and services. Timely innovations give organizations a competitive edge.
  6. The second of the three important types of lead indicators is measurement of process efficiency. Process efficiency is the ability to transform inputs into outputs at lowest cost. There are two types of processes to consider.
    1. Production processes result in the production of products or services. Business processes support production processes. These support activities are essential to the smooth running and operation of any organization. Measures of the efficiency of both production and business processes are lead indicators of financial performance. Four measures of efficiency are discussed below.
    2. One measure of efficiency is measurement of quality. These indicators assess whether customers' expectations have been met.
      1. Customers can be internal or external. Internal customers are employees or subunits that have received partially completed products or services from other employees or subunits. External customers are the final customers, who buy the goods and services. If internal customers receive poor quality, then external customers also will receive poor quality.
      2. Measures of quality must begin at the beginning of a process, where internal customers (employees) can identify and correct problems.
      3. Measures of quality based on external customers 'include customer inquiries about orders (related to on-time delivery), customer complaints, cancellations, and returns.
    3. A second measure of efficiency is measure of productivity.
      1. The simplest measure of productivity is total factor productivity. It is calculated as Total Revenue/Total Cost. Factor productivity can be benchmarked against competitors. The higher the total factor productivity is, the more efficient an operation is.
      2. Other measures of productivity include sales revenue per employee; trends over time; and cost savings from new processes.
    4. A third measure of efficiency is cycle time. Cycle time is the total processing time/number of good units produced. This represents the time from a unit of product being ordered to the time the unit is shipped to the customer. Ideally, the shorter the cycle times the better.
    5. A fourth measure of efficiency is called throughput efficiency. The throughput time ratio is value-added time/total processing time. The lower the ratio is, the more inefficient the process is. This ratio gives managers information about non-value-added activities, which should be eliminated or minimized.
  7. The third of the three types of lead indicators is measurement of customer satisfaction and loyalty.
    1. Measuring customer satisfaction is a lead indicator of future sales. Customer satisfaction measures whether a product or service meets customer needs. Satisfaction is related to characteristics of the product itself - performance of the product, style, adaptability, durability, reliability, safety, and technical specifications. Customer satisfaction is also related to the quality of customer service (before and after the sale). Finally, customer satisfaction is based on customers' willingness to pay the price based on product quality and competitors' product offerings.
    2. Measuring customer loyalty refers to the likelihood that there will be repeat sales. This metric is a lag indicator since it measures how customers have behaved in the past. However, it is also a lead indicator because it gives managers information about retention of customers for new product offerings.
    3. Organizations operating in the competitive market internationally must consider the diversity of social and cultural norms when evaluating customer satisfaction.
  8. Target Costing - Use of a Lead Indicator for Product and Service Design
    1. Target costing is a costmig approach that determines price based on market conditions, profits based on target profits established by the organization, and then designing the product such that product costs do not exceed the amount needed to achieve the target price and profit.
    2. Target cost equals target price minus target profit. Target profit is also known as return on sales.
    3. Target cost is usually achieved by reducing or eliminating non-value-added costs. Achieving the target cost requires that currently feasible total cost be reduced even further as new competition enters a market with even lower prices and costs. Ideally, target cost can be achieved during the design stage of the value chain.
  9. Plans and results must be communicated to the appropriate individuals and sub-units.
    1. Lead indicators must be reported to employees so they can see the link between their job and customer value and profit.
    2. The balanced scorecard is one way to communicate the impact of employee effort to employees.
      1. A balanced scorecard reports both quantitative and qualitative measures of performance.
      2. A balance scorecard is based on a causal model that shows the relation among lead and lag indicators of organizational performance.
      3. A balanced scorecard should link: (1) learning and growth; (2) business and production process efficiencies; (3) customer value; and (4) financial performance. If an organization is able to link the first three, then financial performance (i.e., profit) will follow.
      4. The causal model upon which the balanced scorecard is based is formally stated as:
        @Y = b(@X), where @ is the Greek symbol meaning "delta," or change in; X represents a change in an upstream element, and Y represents a change in a downstream element, or an outcome.