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Three Rules for Sustained Growth in the Middle Market

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Three Rules for Sustained Growth in the Middle Market

A discussion with Michael Raynor, Director at Deloitte, about the three rules midmarket companies must follow for sustained growth.

PCEO: I am very much intrigued by the “three business rules” - and by the way, I love the formulation of the third business rule as “pay attention to the first two” - you went through 25,000 companies over 45 years and you came up with three very distinct rules for long-term performance. Can you explain them?

Michael Raynor: I guess the hope is that what we’ve got are two bedrock principles that can be used to answer, in a systematic way, what we see as the two core questions of any company’s strategy, which is really “how do you create value for your customers and how do you capture value for yourself?”

"And what we found is that sometimes those things mattered, and sometimes they didn't. So to say to somebody “innovation is sometimes important, but sometimes it's not, so be careful,” isn’t particularly helpful."I don’t know that anybody can promise to come up with a step-by-step, turn-by-turn set of directions that will take any particular company from wherever it happens to be to precisely where it wants to go. That level of detailed instruction, were it available, would be more than $17.95 on a book.

But what I think we’ve got is a compass, if you will, for keeping your bearings as you deal with the myriad challenges and questions and uncertainties that any manager or business leader has to face on a day-to-day basis.

PCEO: Both of these relate to revenues. Obviously, rule number one, “better before cheaper” - don't compete on price. And then the second one is “revenue before cost” - you can't cut your way to greatness. I think those have a lot of resonance to a lot of folks.

In terms of rule number one, “better before cheaper,” can you explain that a little bit, particularly in light of the manufacturing sector, for instance, given the pressures U.S. manufacturers have come under with respect to offshore competition having a much lower cost of labor, much lower cost structure?

Raynor: The bad news is that the complete answer is somewhat subtle, but it goes something like this: “Better before cheaper” does not mean that you should spend as much as you can. “Better before cheaper” means that superior, exceptional companies do not compete on price, and that although companies can in fact be successful if they do compete on price, they are far less likely to have exceptional profitability over time.

Companies that show up with a much lower cost base - so they are trading on labor cost, arbitrage, or input arbitrage, something like that - and then cut their prices as a reflection of their lower cost, they can be enormously challenging.

However, our claim is that, especially if somebody has got a structurally lower cost position, the last thing you should try and do is match them on cost. You may have to cut your costs in order to remain competitive, that’s true, but that doesn't mean that the way you should try to seek superior profitability is through having even lower cost, and even lower prices, than they do.

PCEO:   Yeah, because in many ways it’s a losing game to a certain extent. So, let’s say I am middle market CEO John Smith and I am a manufacturer of widgets, and I know for a fact that widgets can be produced in, say, Indonesia cheaper than I can produce them, including shipping cost and all that kind of stuff. What do you tell me in that respect?

Raynor: I guess the question then becomes where you think your competitive advantage is going to lie in the long run. Should you in fact solve the hard problem of relocating your manufacturing facilities to a lower cost location? Because that's a hard problem. Relocating manufacturing to far-flung locales, especially if you end up with manufacturing facilities in a variety of different places, chasing low cost, imposes all kinds of coordination costs, all kinds of quality issues, etc., many of which are often unforeseen.

It becomes, in my view, a much more delicate balancing act between a) is chasing this lower cost going to compromise the non-price dimensions of performance in ways that undermine my competitive position, or b) is it a straightforward good thing, meaning I will suffer no penalties when it comes to differentiation; I will simply get lower cost and that is going to fall straight to the bottom line?

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