The three elementary rules for being great

The April 2013 issue of Harvard Business Review had a very insightful article Three Rules for Making a Company Truly Great by Michael Raynor and Mumtaz Ahmed.

Raynor and Ahmed undertook a statistical study of 25,000 companies that were traded at any time from 1966 to 2010 on U.S. stock exchanges. They measured performance according to return on assets (ROA), a metric they reasoned reliably reflects managerial efforts. Out of the 25,000, they identified several hundred companies that were good enough long enough to qualify as truly exceptional in performance based on their ROA.

What they discovery was startling. They discovered that what was consistent with the top performing companies over their decades of success was “just three seemingly elementary rules:

  1. Better before cheaper – in other words, compete on differentiators other than price.
  2. Revenue before cost – that is, prioritize increasing revenue over reducing costs.
  3. There are no other rules – so change everything you must do to follow Rules 1 and 2.

Here’s a little more about what the authors said about the rules:

Rule 1 – Better before cheaper
“Every company faces a choice: It can compete mainly by offering superior nonprice benefits such as a great brand, an exciting style, or excellent functionality, durability, or convenience; or it can meet some minimal acceptable standard along those dimensions and try to attract customers with lower prices.”

Rule 2 – Revenue before costs
“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.”

Rule 3 – There are no other rules
“When considering all the other determinates of company performance – operational excellence, talent development, leadership style, corporate culture, reward systems, you name it – we saw wide variation among companies of all performance types. There is no doubt that these and other factors matter to corporate performance—how could they not? —but we couldn’t find consistent patterns of how they mattered.

“More telling still, we found individual companies that remained exceptional despite changing their approaches to a number of critical determinants of performance. The reason? The changes they made keep them aligned with the first two rules. In other words, top-performing companies are doggedly persistent in seeking a position unrelated to low prices and adopting a revenue-driven profitability formula, while everything else is up for grabs.”

An finally they advise, “Here’s how to put the rules into operation: The next time you find yourself having to allocate scarce resources among completion priorities, think about which initiatives will contribute most to enhancing 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.” 

To us, Raynor and Ahmed’s findings affirm that the road to long-term profitability (ROA) in the LBE industry is not about price, but rather about offering experiences that are considered high in value, high in Fidelity.