The authors of a large-scale empirical study which was recently published in the Harvard Business Review wanted to settle this core question of management once and for all. Michael E. Raynor and Mumtaz Ahmed, both experienced consultants at Deloitte, examined more than 25,000 companies over a period of 44 years (1966-2010) based on U.S. stock market data. What they found out was surprising even to them: Companies that were exceptionally successful over long periods of time consciously or unconsciously followed only three basic rules:
- Better before cheaper
The first rule to long-term success is to compete not on price but other differentiators, such as brand, design, functionality, or durability of the products. Raynor and Ahmed found that exceptional companies overwhelmingly adopted differentiation strategies while less successful companies typically aimed to gain cost leadership within their industries.
However, one should not forget here that the data used in the study is historical data pertaining exclusively to the U.S. market. Results cannot simply be transferred to other local markets and current economic conditions. For instance, for the rising middle class in emerging markets the price is still one of the most important if not the most important factor when making purchasing decisions. And even in Western countries it is rather challenging these days to sustain a "pure" differentiation strategy in the long-term. Increased competition and cost pressure, shorter innovation cycles, and changing consumer demands are forcing businesses to offer high quality products with differentiated features at the lowest possible prices. Therefore, hybrid strategies that combine the advantages of both cost leadership and differentiation strategies may be most suitable to achieve sustainable success. Raynor und Ahmed take this into account when they remind us to „bear in mind the before in `better before cheaper.´” That is, in certain cases it may be advisable to follow a sequential hybrid strategy which focuses on differentiation first and later switches to cost leadership when copycats start entering the market.
- Revenue before cost
The second rule is to prioritize increasing revenue over reducing costs. Raynor and Ahmed write: “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.”
The second rule is pretty much a logical consequence of the first one since it is difficult to achieve high quality by cutting costs. Especially in times of economic uncertainty, one should always keep this rule in mind, though. While cost reductions may be unavoidable sometimes in order to stay competitive, managers should be very careful not to blindly cut red tape. Budget cuts in strategically important areas may easily turn out to hamper long-tong success.
- There are no other rules—you must follow Rules 1 and 2
The last rule, the authors argue, “underscores the uncomfortable (or liberating) truth that in the pursuit of exceptional profitability, everything but the first two rules should be on the table.” When considering all the other determinants of company performance, such as operational excellence, corporate culture, or leadership style, there was wide variation among companies of all performance types. No patterns could be identified as to how these factors matter in achieving great long-term success. With other words, companies may take any measures they please as long as they are aligned with a growth-driven differentiation strategy.
Here it becomes clear that the three - or basically only two - rules do not offer any concrete advice on how to run a business or how to develop a solid strategy. The rules rather reflect the general mind sets of businesses that have been extremely successful time and again.
If you want to learn more about the methodological approach and the results of the study, we recommend you the book written by Raynor and Ahmed The Three Rules: How Exceptional Companies Think, which will be published on May 30th.
Raynor, M. E., & Ahmed, M. (2013, April). Three rules for making a company truly great. Harvard Business Review. http://hbr.org/2013/04/three-rules-for-making-a-company-truly-great/ar/1?goback=.gde_57447_member_228578876