Several years ago, Deloitte’s Michael Raynor and Mumtaz Ahmed set out to identify the common, underlying ideologies and strategies that could be found in today’s most successful companies. After analyzing thousands of companies using return on assets (ROA) as the metric for stable performance, the duo identified, “three seemingly elementary rules” that seemed to differentiate the most successful companies from the rest of the pack.
While correlation does not imply causation, Raynor explained that “the rules can be applied to help today and tomorrow’s leaders increase the chances that their companies…will deliver decades of exceptional performance.” While managing current portfolio companies — or reviewing new investments — it is worthwhile to consider whether the companies abide by these basic rules.
Better Before Cheaper
In their analysis, Raynor and Ahmed learned that the most successful companies were those that were focused on outperforming the competition through quality — not price. Raynor explained, “Competitive positions built on greater differentiation through brand, style, or reliability are more likely to drive exceptional performance than positions built on lower prices.”
While a strategy focused on price differentiation may yield short-term dominance, it can often be unsustainable. If a portfolio company has gained market leadership through price differentiation, the superior position may be easily shaken with the introduction of new players or shifts in industry dynamics. While a company can adjust its prices, the key to successful execution is not “whether your prices are lower than they used to be but that they remain higher than your rivals’’,” explained Raynor.
Raynor cautioned, “We don’t mean to suggest that a company can afford to ignore its relative price position.” The findings simply suggest that “outstanding performance is caused by greater value and not by lower price. Companies seeking sustained, exceptional profitability should pursue strategies that are consistent with this rule and avoid those that aren’t.” Raynor continued by explaining that the most successful companies, “rely much more on gross margins than on lower costs for their profitability advantage.”
Revenue Before Cost
The second major strategy that has helped guide certain companies to success is the philosophy of “Revenue Before Cost.” The focus on driving profitability through higher revenue — not lower costs — has proven to be a means for companies to achieve consistent excellence, despite micro- and macro-fluctuations.
Raynor explained, “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.” He continued, “Very rarely is cost leadership a driver of superior profitability.”
While cutting costs can be helpful for growth, prioritizing cost efficiency can leave a company focused on its change over time — and not change relative to competition. As Raynor explained in his HBR podcast, “you don’t compete with yourself last year. You compete with your competition today. And so very frequently, organizations have to be more efficient to find ways to cut costs over time simply to stand still with respect to their competition.” If the focus is on cutting costs, especially over time, chances are the company will be stalled.
There Are No Other Rules
Raynor and Ahmed learned that there were no other overarching rules to predict long-term success. As a result, the third rule is do whatever it takes to satisfy rules one and two.
To help companies adopt these strategies, Raynor encourages them to first “get a clear picture of your company’s competitive position and profitability formula.” With this snapshot in mind, “The next time you find yourself having to allocate scarce resources among competing priorities, think about which initiatives will contribute most to enhancing the non-price elements of your position and which will allow you to charge higher prices or to sell in greater volume. Then give those the nod.”