Revenue as a Lagging Indicator

futurelab default header

This post by Paul Graham (Y-Combinator founder) is rich with unique perspective on the really big, ‘frighteningly ambitious’ startup ideas. I like the way in which he frames them (and they are certainly ambitious) by acknowledging that the biggest ideas are always terrifying, not just because they involve so much work, but because they seem to threaten your very identity (“you wonder if you’d have enough ambition to carry them through”).

So whilst any one of those ideas could make you a billionaire, they actually become rather unattractive which means they are effectively invisible to most, and even the most ambitious among us are wise to approach them obliquely. 

This obliquity theme continues later in the post in an intriguing section in which he questions whether a post-Jobs Apple can continue to create new products in the way in which it did under its late founder’s leadership. The conclusion is no. None of the existing players on that field, says Graham, are run by product visionaries. Reading the Isaacson biography of Jobs over the past couple of months (I’m a slow reader), I can appreciate why this might be a quality you can’t hire (“empirically the way you get a product visionary as CEO is for him to found the company and not get fired. So the company that creates the next wave of hardware is probably going to have to be a startup.”). When Apple lost its way in the 80s, it tried to focus on revenues but forgot its essence of creating amazing products. Graham’s point is that whilst Apple’s revenues may continue to rise for a long time: “as Microsoft shows, revenue is a lagging indicator in the technology business”.

I’d argue that in the context of rapidly changing markets and growth in more intangible assets, revenue is a lagging indicator in many different types of businesses. Unfortunately, it often seems to be viewed as a leading one, a behaviour revealing itself in an overly short-sighted focus on short-term financial targets and objectives. 

As far back as the 90s, Norton and Kaplan were talking about the balanced scorecard as a more appropriate approach for a post-industrial information age where exploiting intangible assets has become more important than the ability to manage physical assets. It acknowledges that whilst important, financial measures tell the story of past events and should therefore be supplemented with measured performance from three additional perspectives: customers, internal business processes, and learning and growth.

Operational and management control systems, they say, are often built around financial measures and targets which bear little relation to the company’s progress in achieving long-term strategic objectives. Such non-financial metrics close the gap between the development of a strategy and its implementation, give a more rounded understanding of how the company is really doing, and can predict future financial performance rather than simply report what’s already happened (in Obliquity, John Kay goes as far as saying that we should be wary if a company announces shareholder return as its number one goal since the most profit-orientated companies aren’t usually the most profitable).

Like most things its all about balance. It’s easier to focus on lagging indicators. They are more visible and more tangible. Making investment decisions on the basis of leading indicators feels riskier. The short-term return is less obvious (take social media as an example). But people usually get there before businesses do, so an unbalanced focus on lagging indicators at the expense of leading indicators will tell you very little about whether you will achieve your strategic objectives or indeed how you’re going to get there. I suspect this is a lesson we will have to learn more than once.

Original Post: