Wednesday, 3 June 2015

Three (and a half) rules: Book review

First published in 2013 and out now in Paperback, "The three rules- how exceptional companies think" by Michael Raynor and Mumtaz Ahmed from Deloitte is well worth a read.

To contrast with quite heavy statistical analysis are several graphs that support some surprisingly simple conclusions. The authors set out to find the few rules that identify exceptional companies in the US. Rather than use the case study route or select well known exemplars, they have crunched years and years of financial data and subjected it to analysis, looking for significant, statistically significant, differences.

And the results? Well exceptional companies should follow these rules when having to make decisions on resourcing, strategy, structure:

1 Better before cheaper. So don't compete on price, compete on value.
2 Revenue before cost. Drive profitability with higher revenue, not lower cost.

Their analysis supports these rules, and in searching for further rules, they could not find any others that withstood a rigorous analysis, and hence the last rule is:

3 There are no other rules. Change anything and everything to stay aligned with the first two rules.

Now although there are only three rules, looking simple, following them isn't. In particular that phrase "change anything and everything to stay aligned", means just that. Everything is up for grabs, nothing is sacrosanct. Divisions can be bought or sold, markets conquered or exited.

Intuitively the rules mean that exceptional companies must deliver products or product/services of high value, bought for their high value, and at a higher price point. And when you have done that, driving for more revenue through price or volume should come before cost cutting to improve returns.

The final twist that the authors have identified in the last few years and is explained fully in the Deloitte Review Issue 16 asks the question of how companies reach the level of exceptional in the first place. Reviewing the data and tabulating the results they conclude that when a company is performing poorly and certainly sits in the lower half of the competitive landscape, they should cut "other costs", costs that don't impact on gross margin.

As they rise towards excellence and strive for a return on assets ratio that makes economists salivate they should turn their attention to gross margin, by creating high value propositions. So I would propose the rules can be modified to read:

If performing in the lower half of your peer group sector, cut non-direct costs. Overheads, SG&A need to be brought into line with sector norms.
Better before cheaper. So don't compete on price, compete on value.
Revenue before cost. Drive profitability with higher revenue, not lower cost.
There are no other rules. Change anything and everything to stay aligned with the first two rules.

Read and enjoy.
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