3 Simple Rules for Great Companies

I splurged the other day and bought the April 2013 issue of the Harvard Business Review. At over almost $17 it is not your typical checkout counter purchase. It puts a real dent in your wallet. However, you can also gain immeasurable insights into business and how to do it better. That was the promise I read between the lines in the cover story teaser – “The Three Rules for Success”. Want to know more? Read on.

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The article is a look behind the data of companies that traded on the various US exchanges between 1966 and 2010, a number that amounted to over 25,000 firms. What the authors, Michael E. Raynor and Mumtaz Ahmed, wanted to get at was to understand what truly great long-term successful companies had in common versus the flash in the pan, the flavour of the moment.

As business leaders we are pulled in every direction by the latest and greatest thoughts from business writers. While these books and articles profiling highly successful firms have their place, often the data that the success is built on turns out to be impractical or unreliable in replication. Why? Well, one example would be the environment in a stock market that rallies a sector or a company over a short to medium term. Sheer blind luck to name another, being in the right place at the right time.

What is missing is a refresh of the data to see how the company or the business theory of the day holds up over time. This is precisely what the authors worked to achieve – “Which companies are worth studying? What sets them apart? How can we follow their examples?” Three rules emerged:

RULE #1 – BETTER BEFORE CHEAPER

From the HBR story – ‘Every company faces a choice. It can compete mainly by offering superior non price benefits such as a great brand, an exciting style, or excellent functionality, durability, or convenience; or it can meet some minimal acceptable standard along these dimensions and try to attract customers with lower prices. Miracle Workers (the authors term for the top 10% of the 25,000 companies studied) overwhelmingly adopt non price positioning, not price competition. Average performing companies over the long-term overwhelmingly competed on price.

This is a key insight into your business. I have been there so I know it is true. You compete with many in your chosen market segment or location. Others will enter the market over time. How do you react? So often the tendency is to cut price to keep your market share. What happens? Over time the market share reaches an equilibrium and you are left running a company making less money on similar sales, unable to invest in what made your company strong in the first instance. In my opinion, over time the drive to be cheaper leads to inferior product offering and a lack of innovation. You only have to look at the success of premium sector headphones, the success of Mercedes-Benz, and the turnaround at Apple to see examples of a relentless pursuit of quality and its impact on profitability through the pricing premium derived from that pursuit.

RULE #2 – REVENUE BEFORE COST

From the HBR story – ‘Companies must not only create value but also capture it in the form of profits. By an overwhelming margin, exceptional companies garner superior profits by achieving higher revenue than their rivals, through either higher prices or greater volume. Very rarely is cost leadership a driver of superior profitability.’

In a recessionary environment cost of operations is the thing that gets so much attention from corporate leadership. Now, don’t get me wrong, it’s needed. In good times we often take our focus off of cost control and a recession essentially forces us as leaders to make a correction that recalls the leaner startup days. However, the cost cutting cycle can go too far and occupy so much of the mind of management that the opposite side can be ignored. Working relentlessly to drive revenue into the company is, it turns out, more of a predictor of long-term success than continually working to cut your costs. Drive revenue through higher prices (think quality here) or build relative sector volume. Over the long haul this approach is far more effective than working to increase profitability through low operational cost leadership.

RULE #3 – THERE ARE NO OTHER RULES

From the HBR story – ‘This rule underscores the uncomfortable (or liberating) truth that in the pursuit of exceptional profitability, everything but the first two rules should be on the table.’

What does this mean? Well, business functions such as operational excellence, human capital development, corporate culture and leadership / management styles are factors that impact business performance. I am convinced effective execution of these and so many other factors can impact the performance of the organisation. However, over the long-term a company keeps its eye on delivering its product or service with quality that is higher than its rivals, or a company that is successful in driving revenue in through higher prices or volume, will prove to be the winner.

In a dynamic social world that pushes a ton of really great content at us as business leaders, the findings summarised here and elaborated on in the HBR story bring a level of simplicity and clarity to what we do. For me the article was an eye opener. There is certainly a place for a good business book, but sometimes key fundamentals such as these trump all else.

What have been your experiences with managing a company in recession or transition? Were quality or revenue high on your list? Share your thoughts in a comment below.

I live in the Cayman Islands and I'm married to Christina. We have two incredible children. A serial entrepreneur, I own several businesses in Cayman. I'm currently chairman of the Special Economic Zone Authority, and past president of the Rotary Club of Grand Cayman, and the Cayman Islands Chamber of Commerce.

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One thought on “3 Simple Rules for Great Companies

  1. And the gains that we achieve from prudent actions in lean times may we not squander them when prosperity returns.