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Three Rules for Sustained Growth in the Middle Market

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"Your relevant competition are those companies, products, services, solutions that your customers see as potential substitutes for what you do; your competition is not simply the set of companies that you think you are competing with."

My view is that the the notion of finding a $20 bill lying in the gutter just beggar’s credulity, and so it requires a set of decision-making biases when it comes to making these choices. What we have learned is that the companies that deliver superior performance over time are the companies that bias those decisions on the basis of “better before cheaper” and “revenue before cost.”

Sometimes it's a slam dunk. Sometimes the data is so absolutely incontrovertible, no reasonable person would disagree. But far more often, it really is a judgment call.   And what we are saying is that the judgment that should carry the day is captured in our two rules.

PCEO: Are there some big rules other than those two rules that you found?

Raynor: Well, not really. In fact, I will answer that backwards. No, because that's why we’re stuck with the third rule - there are no other rules. We ended up looking at all of the other things that matter to corporate performance: innovation, leadership, culture, reward systems, talent recruitment and retention, merger and acquisition activity, international expansion, you name it. It's a very long list of things that we know have an impact on corporate performance.

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.

What we concluded is that the only way you could make those choices was by looking at the specifics of a particular issue through the lens of “better before cheaper” and “revenue before cost,” and then that's when things started to make sense.

Innovations that were designed purely to reduce costs were not innovations that drove long-term superior profitability. Innovations that found ways to deliver higher quality at less- than-proportionately higher cost are the innovations that seem to make the difference. So that's sort of how we ended up with our third rule.

Now, in terms of how we defined superior long-term performance, we were looking at profitability as measured by return on assets, and we were looking at the ability of companies to deliver lifetime superior profitability. So these are companies that are statistically exceptional over their full observed lifetimes.

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