While the majority of businesses are still trying to survive amid the economic turmoil of recent years, some companies are managing to thrive, and a new book attempts to identity what sets them apart.
“The Three Rules: How Exceptional Companies Think,” by Michael Raynor, a director at Deloitte Services LP, and Mumtaz Ahmed, chief strategy officer at Deloitte LLP, is a new book that explains the basic rules that distinguish successful companies such as Apple, Merck, Maytag and Abercrombie & Fitch from their rivals:
1. Better before cheaper: Do not compete on price.
2. Revenue before cost: Do not try to “cut” your way to greatness.
3. There are no other rules: Do not give up on the first two rules; everything else is up for grabs.
“Our evidence shows that companies that follow these rules are systematically more likely to deliver exceptional profitability over the long term,” Raynor told me in an interview last Friday. He and Ahmed spent five years researching such companies and what distinguishes them from the competition.
“A lot of business folks tend to be quite sympathetic to the notion that you want to avoid price-based competition, and the notion that you can’t endlessly cut costs in order to improve profits is something that most people tend to accept pretty quickly,” said Raynor. “However, what we tend to see is that as soon as companies meet the merest sort of adversity, it’s extraordinarily tempting and often irresistible for them to reach for those price and cost levers. What we’re hoping is that the evidence that we have in support of the rules can give managers the courage and confidence to do what many of them believe they should.”
However, according to the data that Raynor and Ahmed have reviewed, companies all too often lack the conviction and persistence to stick with the three rules they have outlined in ways that allow businesses to differentiate themselves from the competition. From their statistical analysis of publicly traded companies in the period between 1966 and 2010, they identified 344 exceptional companies. They examined in greater detail 18 companies that they considered to be exceptionally high-performing firms and were able to show that systematically, the companies relied on superior gross margins in order to drive their return-on-assets advantage.
“Based on our case study analysis, we were able to show that in the vast majority of cases, companies achieve their superior gross margins through higher prices and superior asset turns through higher volume rather than by driving down costs or asset basis,” said Raynor.
The companies followed different approaches to achieving high performance, in part depending on what industry they were in, whether it was pharmaceuticals, retail, trucking, semiconductor manufacturing or another sector. But the common threads were “better before cheaper” and “revenue before cost.”
“In sports the saying goes that everyone has the will to win, but not everyone has the will to train to win,” said Raynor. “Very often what separates great athletes from also-rans is the willingness to train rather than merely the desire to win. A lot of managers will nod their heads and say, ‘Sure, of course, don’t compete on price, don’t relentlessly cut costs.’ But the companies that manage to deliver superior performance are the companies that remain committed to solving those problems, even when it’s extraordinarily difficult to do so.”
Raynor sees the rules as a compass rather than as a detailed step-by-step set of instructions for how to get to a particular position or a profitability formula. “They do identify true north,” he said. “They tell you which direction you need to be headed consistently over time. If you’re lost in the woods and you know that civilization lies north, but you don’t know which way is north, if I give you a compass, I’ve done you a great favor. There’s still a lot of hard work for you to do, because you can’t just put your head down and head north. You’ll bump into trees and walk off cliffs and trip into quicksand. Heavens knows what will happen to you. So you need to be quite creative in terms of moving east or west or sometimes doubling back south. But what the rules do is they allow you to keep track of all the various choices that you’re making as an organization over time so that you can be sure that wherever you have the opportunity to bias your decisions toward better before cheaper and revenue before cost, that’s what you in fact do so that over time you are able to separate yourself from the competition. Even though they believe the same sort of thing, at least on the surface, they may lack the conviction. As a result you will more consistently follow the rules over time and as a consequence separate yourself from the rest of the pack. The rules really are decision-making principles and a compass to guide the choices that you make over time.”