If you want your business to be extraordinary, there are three rules you should follow. They won't guarantee success. But research by Michael Raynor and Mumtaz Ahmed of Deloitte Consulting LLP, published in their new book The Three Rules, found that those rules distinguished extraordinarily successful companies in recent years from so-so companies.
The duo started by analyzing 45 years of data on more than 25,000 companies, settling on sets of three companies from nine different industries to pursue further. One group was labelled Miracle Workers because the companies were the top performers from 1966 to 2010. The members of the second group, Long Runners, were still exceptional but at a lower level albeit for a long period of time. Finally, the Average Joes lagged behind.
In trucking, for example, Heartland Express was the Miracle Worker, Werner Enterprises the Long Runner, and P.A.M. Transportation Services the Average Joe. For appliances, the ranking was Maytag, HMI Industries, and Whirlpool. For confectionary, it was William Wrigley Jr. Co., Tootsie Roll Industries, and Rocky Mountain Chocolate Factory.
The researchers then started to look for behavioural differences with trucking, assuming that the approach to mergers and acquisitions in an industry that had been deregulated would be crucial. The idea that acquiring other companies would be helpful was dampened when it became clear the Average Joe company has more acquisitions than the more successful Long Runner. That, of course, suggested mergers and acquisitions might be harmful, another plausible and potentially helpful proposition, until it was discovered the Miracle Worker was the most successful acquirer. The only principle that industry analysis suggested was "do the right deals the right way," which of course is not helpful for strategists.
As the researchers persisted through the entire sample, evaluating different corporate behaviours, the results were consistent only in their inconsistency. There was no pattern for success. "We burned a couple of years building detailed analyses of the companies without coming up with helpful advice," says Mr. Raynor, who is based in Mississauga, Ont.
But a useful explanatory framework began to emerge when they shifted their emphasis from what the companies did to a series of hypotheses about what they thought. It turned out the Miracle Workers made choices that were consistent with three specific rules while the Long Runners and Average Joes systematically violated those rules:
Better before cheaper
Companies can distinguish themselves from the competition by price – selling for less than the competition – or by non-price, where they try to be better according to other criteria of quality that buyers prize.
"Systematically, exceptional companies differentiate on non-price factors," Mr. Raynor says. Miracle Workers overwhelmingly took non-price positions in setting their positioning strategy, while Long Runners tended to be in the middle, showing no tendency one way or the other. Average Joes competed (comparatively unsuccessfully) on price. If you can be better and cheaper, he says that's wonderful. But if you must choose, be better.
Moreover, when a successful company abandoned a non-price position, their performance subsequently suffered. Maytag was a quality leader – and highly successful – until the mid-1980s. Afraid of damage from big-box stores with so many offerings, it diversified its product line without the same quality focus and it hit a tailspin. It was ultimately acquired by Whirlpool.
Revenue before cost
In seeking profitability, many companies are tempted by cost cutting. But the research showed that the profitability formula for the best companies was to drive up their return on assets through higher relative revenue than by lower relative cost or lower relative assets. "This surprises people a lot more," Mr. Raynor says. "Some people have felt in their gut they should compete on quality. But when we say superior profitability does not depend on cost, people have to think more."
The exceptional companies drive revenue through higher prices, which they are able to maintain despite competitive environments, or greater volume. They tend to have higher costs than competitors – even in price-sensitive industries.
There are no other rules
Those two rules tell you what is needed for success. So when making decisions, you must relate the possibilities to those two rules. If considering a merger or acquisition, determine if it can help you be better than your competitors on non-price factors or raise revenue, rather than being driven by the lure of lower prices or lower costs.
If you want to focus on talent and developing people, figure out how doing so helps you gain an advantage in the area the two other rules frame – because developing people or seeking acquisitions, by themselves, are not sufficient.
Mr. Raynor believes the rules are important because they provide meaningful advice. Many people, after all, think that being cheaper than the competition and constantly cost-cutting is an effective strategy. That seems reasonable.
But the rules suggest the opposite will be more effective. At the same time, he stresses "these are not laws of physics. They are just rules." So there is no guarantee of success if you follow them. And some companies will do the opposite and still succeed. But he notes that just as it's preferable to go with the grain of the wood in carpentry, the three rules tell you where your best bet lies.
Special to The Globe and Mail
Harvey Schachter is a Battersea, Ont.-based writer specializing in management issues. He writes Monday Morning Manager and management book reviews for the print edition of Report on Business and an online work-life column Balance. E-mail Harvey Schachter