I have a bookcase full of so-called “success studies.” These are books that purport to offer the secret to exceptional corporate performance. Indeed, I have reviewed several of them in this column over the years.
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The Three Rules: How Exceptional Companies Think is a book that should appeal to both executives and students of business.
Michael E. Raynor and Mumtaz Ahmed, The Three Rules: How Exceptional Companies Think. Penguin, 2013.
These studies have become their own industry over the last several decades. The genre was effectively launched in 1982 with In Search of Excellence by Tom Peters and Robert Waterman. In recent years, this market has been dominated by Jim Collins with books such as Good to Great and Great by Choice, among others.
Such studies tend to be highly controversial. Often, the companies identified as exceptional subsequently falter. In fact, this led Mr. Collins to produce another volume entitled How the Mighty Fall, which looked at why some of his “great” companies fell on hard times. Much of the criticism has focused on the methods used to identify exemplary companies.
For example, companies were selected for In Search of Excellence based on a canvass of a “who’s cool” list among partners of consulting firm McKinsey & Co. The consultants then applied some quantitative measures to whittle the list down to the “excellent 43.”
The Three Rules is the latest entry into this market and is perhaps the most methodologically rigorous of the genre to date. This is not an easy book to read. It is data-laden with a heavy emphasis on research design and standards of evidence. It often reads more like a PhD thesis than a popular business book. A third of the book is dedicated to appendices discussing various methodological issues.
The authors are both from Deloitte. Michael Raynor is a director at Deloitte Services LP in Canada while Mumtaz Ahmed is the chief strategy officer of Deloitte LLP.
To overcome some of the methodological issues that plagued previous studies, the authors and their team analyzed 45 years of financial, statistical and market data on more than 25,000 companies from hundreds of industries. They identified 344 companies that qualified as statistically exceptional based on their return on assets over a long period. After five years of work, they could not find any consistent pattern of behaviour that separated exceptional companies from their unexceptional industry peers.
Eventually, they shifted their attention from what people in these companies did to a series of hypotheses about how they “thought” or the decision criteria that they used. This approach caused them to conclude that the real differentiator was that exceptional companies had people who consistently made the best decisions about what not to do and how to do what needs to be done. This led to their three “decision” rules.
First, they found that non-price positions were systematically more profitable and more sustainable than price-based positions. Hence, Rule No. 1: “Better before cheaper.” The companies that sustained their performance over time did so by establishing durable non-price benefits such as a great brand, style, etc. as opposed to competing on price.
They also discovered that exceptional companies had a common profitability formula. When faced with a tradeoff between increasing profitability by growing revenue or decreasing costs, they systematically chose increasing revenue even if this incurred higher costs. This led to the second rule: “Revenue before costs.”
While they admit that price-based positions and cost-driven profitability can work, the authors suggest that they work less well than non-price-based positions and revenue-driven profitability formulas.
The third rule, the authors write, is that there are no other rules. Sustained success is based on adherence to the first two.
Interestingly, the authors found that things such as superior innovation and leadership styles were not key determinants of success. Rather, what mattered more was how they contributed to the company’s adherence to the first two rules.
Unlike some of the other books, The Three Rules does not offer a blueprint for success. Exceptional companies, the authors suggest, may all have the same recipe but use different ingredients – for example, there is no specific formula for creating non-price positions.
Rather, the book tries to offer guidance when it comes to making some of the tradeoffs that companies face when establishing a competitive position.
This is a book that should appeal to both executives and students of business.
Micheál Kelly is dean of the School of Business & Economics at Wilfrid Laurier University and former dean of the Telfer School of Management at the University of Ottawa.