The 3 rules of corporate success are:
1. Better before cheaper,
2. Revenue before cost.
3. There’re no other rules
Success study
The impetus of the research for the book, was the increasing popularity over the past 30 years of “success study” business books and articles. Perhaps the most famous of these are Thomas Peters and Robert Waterman’s In Search of Excellence (1982) and Jim Collins’s Good to Great (2001), but there are many others. The problem with them is they don’t give us any way to judge whether the companies they hold up as examples are indeed exceptional.
Success is random
Randomness can crown an average company king for a year, two years, even a decade, before performance reverts to the main. If we can’t be sure that the performance of companies mentioned in success studies was caused by more than just luck, we can’t know whether to imitate their behaviours.
Three rules
The three rules constitute useful advice because they define which of many plausible alternatives is systematically associated with exceptional performance.
- Better before cheaper does not mean price competition is irrelevant; it means that when you have a choice to make, and when the data are unclear, go with better.
- Revenue before cost does not mean keeping the cost under control does not matter; it means increasing revenue is more important.
- There are no other rules does not mean you can blindly follow the rules; it means you must apply all your creativity and insight to follow them in the face of all manner of other changes.
The background
The authors tackled the randomness problem head-on. Finding what they assumed would be weak signals in noisy environments required a lot of data, so they began with the largest database they could find—the more than 25,000 companies that have traded on U.S. exchanges at any time from 1966 to 2010. They measured performance using return on assets (ROA), a metric that reflects strong, stable performance, unlike, say, total shareholder return, which may reflect the vagaries of the stock market and changes in investor expectations rather than fundamental company performance.
Superior results
They defined two categories of superior results
- Miracle Workers fell in the top 10% of ROA for all 25,000 companies often enough that their performance was highly unlikely to have been a fluke;
- Long Runners fell in the top 20% to 40% and, again, did so consistently enough that luck was highly unlikely to have been the reason. They call the companies in both these categories exceptional performers.
- For comparison purposes, they also identified companies that were Average Joes.
Don’t believe what you read
174 companies qualified as Miracle Workers, and 170 qualified as Long Runners. That’s the entire population of companies that separated themselves from the noise in this way. It’s probably worth mentioning that of the allegedly superior companies mentioned by 19 high-profile success studies we examined (the one mentioned in books), barely 12% met our criteria, even for Long Runner status. Don’t believe all that you read.
Do the right thing school of management
Get the right people on the bus! (Did anyone ever want the wrong people?). Have a clear strategy! (Does anyone ever set out to create a confusing one?). Give customers what they want! (Who deliberately gives them what they don’t want?). All these are taken from well-read success studies. Was customer focus the key? Nope. Innovation? Risk-taking? Nope and nope. All these factors were associated with great, good, or average performance in pretty much equal measure. It was reduced to a two-word sentence of surrender: “It depends.”
What sort of leadership best leads to corporate success?
As far as the authors could tell, all that mattered consistently was whether or not leadership was focused on building a non-price position and a revenue-driven profitability formula. Exceptional companies realise that non-price value must be earned repeatedly and continuously. A company’s competitive position defines how it creates value. A company’s profitability formula defines how it captures value. Profitability increases when revenue increases, cost decreases, or assets go down. We find that exceptional companies achieve superior profitability with revenue increases, even if that means higher cost or a higher asset base.
The halo effect
The bedrock assumption of every success study is that one can infer the causes of differences in performance by comparing the behaviours of companies with higher performance with the behaviours of companies with lower performance. Most success studies set performance benchmarks that are intuitively demanding and then declare that any companies clearing those benchmarks have achieved superior performance. The “halo effect,” which is manifest when superior performance leads commentators to attribute all manner of positive attributes to anything and perhaps everything a company does. When the stock is up, leadership is decisive and bold; when the stock is down, the same people magically become narrow-minded and arrogant.
Don’t believe the case studies
This would not be a problem except that many success studies rely on the journalistic record as a major source of data. Consequently, in the words of one commentator, many of the most famous success studies are not studies of what causes great behaviour but studies of how great behaviour is described. We are corporate palaeontologists, forced by circumstance to deal only with the fossil record.
No patterns
When considering all the other determinants of company performance, operational excellence, talent development, leadership style, corporate culture, reward systems, you name it—they saw wide variation among companies of all performance types. There’s no doubt that these and other factors matter to corporate performance, how could they not, but they couldn’t find consistent patterns of how they mattered.
Case studies
In pharmaceuticals the top companies have successfully moved from in-house to joint-venture to open innovation, while in semiconductors we’ve seen increased capital investment and an expanding portfolio of customers, all in support of better before cheaper. In confectionery, the top performers have shifted from domestic to global distribution, and in medical devices, M&A has become a cornerstone of growth. When these changes have led to superior profitability, it has been because they contributed to greater volume more than to lower costs. But when you compete on price, a faster gun always seems to come to town eventually.
Here’s how to put the rules into operation
The next time you find yourself having to allocate scarce resources among competing priorities, think about which initiatives will contribute most to enhancing the nonprice elements of your position and which will allow you to charge higher prices or to sell in greater volume. Then give those the nod. If your operational-effectiveness program is mostly about cutting costs, whereas your innovation efforts are mostly about separating you from the pack, go with innovation. But if pushing the envelope on operations is about delivering levels of customer service way above your competition’s, whereas innovation seems geared to doing the same for less, then your operations folks deserve the additional care and feeding.
