A director at Deloitte Services and coauthor of The Three Rules: How Exceptional Companies Think, Michael Raynor joins the Fool to share his findings about what makes a company successful for the long haul.
In this video segment, Michael explains how the study defined and identified exceptional performance, and what common threads it found running through the outstanding businesses. He and his coauthor were ultimately able to identify what qualities are -- and aren't -- shared by these exceptional companies.
A full transcript follows the video.
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Brendan Byrnes: Could you walk us through some of the metrics that you used specifically, in identifying those? Also, that's very quantitatively focused. What about qualitative aspects? How do you incorporate that? A company's brand, for example, competitive advantage ... intangible assets, how do you incorporate those?
Michael Raynor: Sure. Well, we kept it pretty simple when it came to measuring performance. We focused on profitability, as measured by return on assets.
There are other measures of company performance, of course. No measure captures everything, but if you accept the fact that profitability is an important measure, then we have something potentially useful to say.
We were able to do some statistical analysis on that population of exceptional companies and get a general feel for the financial shape, if you will, of their performance advantage, but then we had to look under the hood.
We did some in-depth, very detailed case studies on the 27 companies in total, 18 of which were exceptional. We had nine trios: a Miracle Worker, a Long Runner, and then what we called an Average Joe -- a company that had average performance, average volatility, average lifespan.
Byrnes: Could you walk us through the three rules that separated these exceptional companies from the pack?
Raynor: Absolutely. It was a bit of a journey to get there, because we originally started out trying to understand the behaviors that made the difference. Was it M&A? Was it diversification? Was it focus? Was it innovation? None of those things were systematically related.
What we landed on were these three rules -- essentially, decision-making principles that were implied by the actions that these companies took, over time. There were three.
The first of them is "Better Before Cheaper." When it comes to how a company creates value for its customers, differentiate yourself based on being better than the competition, not being cheaper than the competition.
But creating value's not enough. You have to capture some for yourself, in the form of profits. There, it's "Revenue Before Cost."
We think that's important, because you can drive profitability any way you want. Math doesn't care, but reality does. Companies that deliver exceptional performance systematically focus on building revenue through either price or volume, and they tend not to have cost advantages, which was a bit of a surprise.
Then finally the third rule, "There Are No Other Rules." The reason we think that's important is that it's really easy to fall into the trap of thinking, "There must be something about leadership. There must be something about culture. There must be something about all these other things that we know matter, but that don't appear to matter in a systematic way."
The third rule says, "Change anything you have to, in order to hew to Rule 1 and Rule 2."