Great Companies Follow These Three Scientifically-Proven Rules

I'm going to jump right to the point and show you the three rules that Harvard Business School researchers determined nearly all long-term, great companies followed. Here they are:

1. Better before cheaper. Great companies compete on differentiators other than price.
2. Revenue before cost. Great companies prioritize increasing revenue over containing or reducing costs.
3. There are no other rules. Change anything you must to follow Rules 1 and 2.

How Did They Discover Them?

Interestingly, the Harvard researchers started out looking for common actions that great companies all took, with the assumption being that there must be something they were all doing that made them be great. At the time (2013), there were a lot of well-known books coming out that purported to identify the commonalities in great companies. However, most business gurus underestimated (or ignored altogether) the power of chance. That variable made it really difficult to rigorously prove that certain decisions, or choices, were the cause of greatness.

So Harvard set about trying to remove chance from the equation. First they came up with a set of rules based on return on assets (ROA) to define great and nearly-great, publicly-traded companies between 1966 and 2010. Then they did a statistical analysis of more than 25,000 companies. They found ultimately that great companies made a dizzying array of business decisions. There was no one or two things that they all did in common. In other words, the answer to their question, What makes a company great?, is unfortunately, It depends.

Scientists hate that.

So they switched their focus from what companies did, to what they thought. In other words, maybe great companies made choices that were right for them, in a common way. It turned out that great companies were surprisingly consistent in how they thought about things.

Better Before Cheaper

Every company has to decide if they're going to compete on price, or on something else: a great brand, high quality products, exceptional service, durability or convenience. Companies that compete on non-price factors can charge a premium above the lowest-cost competitors. You can be a successful as the low-cost leader in your industry, but you will always be in a race to the bottom. Bare-bones margins eliminate flexibility when market factors change. When companies abandon their non-price factors, they typically fall from greatness.

Harvard used the example of the appliance company Maytag, which was known for reliability and durability. From 1966 through the mid-80s, Maytag qualified for great status in Harvard's study. Ultimately Maytag chose to compete with the big box retailers by diversifying their product line and lowering prices. Their performance consequently fell and they were eventually bought out by Whirlpool in 2006.

This is not to say that "premium" companies can ignore pricing. What Rule 1 demonstrates is that you can achieve better performance by providing greater value more so than by having the lowest prices around. They also emphasize that the rule is, "better before cheaper." If the competitive landscape changes, you can lower your prices to stay competitive. What matters is that your prices (and your quality) are higher than your competitors.

Revenue Before Cost

Great companies need to create value, but they also need to capture that value in the form of revenue and profits. You can increase profits with higher prices or through greater volume. What Harvard found was that being the cheapest very rarely led to being the most profitable. 

It's fairly obvious that higher prices can result in higher profits. However, Harvard found an impressive variety of companies that built great companies based on this idea.

For example, many of Family Dollar Stores' customers are poor, and yet they command higher prices, and higher profits, than many other discount retailers. Why? They offer superior convenience and better selection. They accept higher costs and lower efficiency to place stores in locations that are easy for their customers to get to. Harvard determined that their higher gross margins consistently resulted in a superior ROA over decades. 

There Are No Other Rules

Business leaders yearn for easy truths or axioms that they think will lead to success. The uncomfortable truth that Harvard found is that only Rules 1 and 2 above matter. If you want to be a successful leader, whether in a public corporation, or in your entrepreneurial business, then everything else must be on the table.

This is not to say that other choices aren't important. For example, companies that give equal importance and value to all three of their constituents (customers, employees, and owners/shareholders) tend to do better than companies that prioritize one (e.g., stock price) over everything else. And many of your choices can influence or improve quality or revenue. For example, having an awesome company culture can make employees love to work for you, which in turn means they do their best work, yielding better quality products.

The absence of other rules does not mean that you don't have to think about all these other factors. In fact, it's almost the opposite: it takes exceptional creativity and leadership to find ways to navigate a tough competitive and economic landscape while staying true to these rules.

But at least now you know what the rules are, which puts you one hundreds steps ahead of a lot of your competitors.

You can find the original Harvard Business Review articles here.