Magic Numbers in Leadership: The Power of Leading Versus Lagging Indicators
“Simplicity is the ultimate sophistication.” – Leonardo DaVinci
“What gets measured gets managed.” – Peter Drucker
How Typical Managers Manage
Imagine you are coaching your daughter’s third grade soccer team. At the beginning of the game, you tell your team that their objective is to score five goals and to keep the opposing team to one goal or less. At halftime, you are down 3-0. You tell your team, “This is not what we talked about. Do you not remember the metrics we established at the beginning of the game? Now go out there and hit your numbers!”
Reminding the team that their objective is to score five goals is not great coaching. Just like reminding your team of their revenue targets and “holding them accountable” to those targets is not great management; it’s just keeping the score. Your accountants can keep score. You need to lead your team.
Revenue, EBITDA, and the score of the game are examples of lagging indicators. They represent the results we hope to achieve. These numbers are outcomes of activities in which you and your team engage, and they show up at the end of the journey, hence the term “lagging.” Lagging indicators tell us the score, but they don’t tell us much about how to play the game.
Leading Indicators
Great leaders manage using leading indicators. Leading indicators are the results that precede your ultimate objective.
The best leading indicators have four characteristics:
They precede the goal,
They have significant impact on and are highly predictive of the achievement of the goal,
They can be directly attributed to activities within your team’s control,
They are actively measured, communicated, and publicized.
Enterprise Rent-A-Car’s Magic Number
The single leading indicator that is most important to your company and most predictive of success is what I call your Magic Number. Magic Numbers vary by company. They are not always obvious or widely followed by the industry. Creating the right Magic Number will not only be predictive of your success, but will also impact your team’s activity and ultimately your company’s entire strategy.
One of the most famous Magic Numbers was created in the early 1990s by Enterprise Rent-A-Car (Enterprise) as described by Fred Reichheld in his book, “The Ultimate Question.” Like many companies, Enterprise issued customer satisfaction surveys, initially using a 17-question survey. After trial and error, they found that customer satisfaction could be measured by a single question survey with a scale of 1-5 asking:
How would you rate your last Enterprise experience?
Enterprise CEO Andy Taylor began a rigorous data crunching exercise and found that nearly 90% of all company referrals came from people who had rated Enterprise a five out of five (“promoters”) and as a result, individual branches with the highest percentage of promoters grew the fastest.
Enterprise began publishing promoter scores for every location, and requiring managers to clear a certain promoter threshold to even be eligible for promotion. The company taught managers how to improve this metric and to follow up with and learn from customers who had rated Enterprise lower than five. In the decade following the implementation of this metric, Enterprise grew revenue from $2 billion to $7 billion, surpassing Hertz as the largest car rental company in the world. The metric Enterprise used—the single question customer survey—would become the basis for what is now known as the Net Promoter Score (NPS). You can read more about the origins of NPS in this Harvard Business Review article.
By creating the Net Promoter Score, Enterprise designed a leading indicator that was simple, measurable, controllable, and highly correlated to the lagging indicators of growth and profitability. The NPS became Enterprise’s Magic Number.
In his research, Reichheld found that NPS was highly correlated to growth rate in a wide range of industries including rental cars, life insurance, airlines, and supermarkets. Since then, Net Promoter Scores have become central to many companies' measures of success. NPS has inspired additional measurements, like employee Net Promoter Scores (eNPS) which Alpine uses at our HQ and at our portfolio companies.
Activity-based Magic Numbers
In some situations, the best Magic Numbers are simple metrics designed to encourage a high volume of interim activities which are highly correlated to the ultimate goal.
In his bestselling book, “Atomic Habits,” James Clear tells the story of Jerry Ueslmann, a professor at the University of Florida. Professor Ueslmann divided his photography classes into two groups. The first group was to be graded on the quantity of photos they took. One hundred photos would get an A, 90 photos would get a B, and so on. The second group was to take the “perfect” photo. Their grade was based on the quality of the photo they took.
At the end of the term, Professor Ueslmann found that without exception, all the best photos came from the quantity group, not the quality group. The quantity group took action, experimented, tried things, and ultimately produced higher quality work.
I see a similar dynamic when our teams (or CEOs-in-Residence or search fund executives) are evaluating industries. They often get analysis paralysis. The most successful teams behave like Professor Ueslmann’s quantity group. They start with a “good enough” thesis and then they begin talking to companies in those industries. They learn more from talking to companies than they could ever learn in a San Francisco conference room. The Magic Number that will most predict success is the number of companies in “good enough” industries with whom they actually have a meeting or phone call. The goal is not to lower one’s bar for ultimate industry selection. Like in the photography example, the goal is to get to a better outcome via increased activity and at bats.
Similarly, Tim Ferriss describes the Magic Number which enabled him to write five best selling books, “My quota for writing was two crappy pages per day.” Magic Numbers in my personal life include number of minutes per day of exercise, number of days per week in which I write, and (most importantly) number of hours of sleep I get per night.
Activity-based Magic Numbers are powerful management tools because activity precedes results, promotes experimentation, increases learning, and reduces paralysis. Activity is typically the easiest metric to manage and improve because it is often within the control of the employees.
My Favorite Magic Number
At Alpine, we have invested in several hundred companies over more than 20 years. In most cases, we bring in our own CEOs to run these companies. During Alpine’s first decade, we invested in CEOs with very different leadership styles and management philosophies. Over time, we noticed that the most successful CEOs all did the same thing. They followed what Jim Collins describes in his management classic, “Good to Great.”
They first got the right people on the bus and the wrong people off the bus.
When our CEOs built a world-class executive team early on, those hires then hired other high-caliber people. The companies produced results that nearly always exceeded our expectations—often wildly. When they didn’t build a strong team, they didn’t experience as much success. My favorite Magic Number is the number of world-class leaders hired on the executive team in the first 18-24 months after our investment.
Like the best leading indicators, the number of world-class leaders is a metric that our team can directly impact. We can work with CEOs to map out a clear path to hire world-class executives, and we can help them find, evaluate, and attract them.
Summary
Did the management team of Enterprise Rent-A-Car drop all activities and focus on their net promoter score? Of course not. They still built and leased locations, procured cars, built IT systems, marketed to customers, staffed their locations, and capitalized their business. Each of these activities likely had their own leading indicators and Magic Numbers. What Enterprise did well is to take the time to find a leading metric that was most highly correlated to individual branch growth, measure it, clearly communicate it to the team, and rally their branch managers around it.
Tony Robbins said, “Complexity is the enemy of execution.” Leadership is often about what you give your team permission not to focus on. Don’t give your team 17 metrics. Establish a few core Magic Numbers and you will unleash your team to focus on what’s truly important.
What is your Magic Number?