Lessons from the Titans

1. Business systems drive sustainable success, not quick fixes

The most successful companies emphasize systems and processes over quick fixes, systems that incentivize and drive continuous improvement throughout the organization over an extended period of time.

Systems beat quick fixes. Successful companies implement comprehensive business systems that focus on continuous improvement rather than relying on short-term solutions. These systems:

• Provide a framework for consistent decision-making
• Align employee actions with company goals
• Foster a culture of ongoing optimization

Examples of effective business systems include:

• Danaher Business System (DBS)
• Toyota Production System (TPS)
• Honeywell Operating System (HOS)

These systems ensure that improvement efforts are sustained over time, even as leadership changes or market conditions fluctuate.

2. Lean manufacturing is crucial for long-term competitiveness

We've never come across a company that was bad at manufacturing and still managed to succeed in the long run.

Lean is foundational. Lean manufacturing principles, originated by Toyota, are essential for long-term success in industrial companies. Key benefits include:

• Elimination of waste in production processes
• Faster production times to meet variable customer demand
• Lower inventory levels
• Higher product quality (fewer defects)
• Improved cash flow and profit margins

Lean practices extend beyond the factory floor, influencing all aspects of an organization. Companies that excel in Lean manufacturing can:

• Generate higher cash flows
• Reinvest in their businesses more effectively
• Withstand economic downturns better than competitors

Even in high-margin industries like software, adopting Lean principles can provide a significant competitive advantage.

3. Cash flow and capital deployment are key to compounding growth

The companies that rose to the top in our study used their high and growing cash flows to widen the moat within their existing businesses while gravitating investments to higher-return opportunities—and repeated these actions over and over.

Cash flow fuels growth. Successful companies focus on generating strong cash flows and deploying capital effectively. This approach enables them to:

• Reinvest in their core businesses to maintain competitiveness
• Pursue high-return acquisition opportunities
• Compound growth over time

The "flywheel effect" occurs when companies:

1. Generate strong cash flows from efficient operations
2. Invest in high-return opportunities (internal or acquisitions)
3. Improve newly acquired businesses using proven systems
4. Generate even more cash flow, restarting the cycle

Companies like Danaher and Roper Technologies have demonstrated the power of this compounding growth strategy over decades.

4. Disruption is overrated; incremental improvements drive most value

Most companies do it once, providing the foundation for their existence, and then never do it again at anywhere close to the impact of that foundational event.

Incremental beats disruptive. While disruptive innovation receives significant attention, most long-term value is created through:

• Continuous, incremental product improvements
• Optimization of manufacturing processes
• Expansion into adjacent markets

Examples of successful incremental innovation:

• 3M's ongoing improvements to adhesive products
• TransDigm's focus on optimizing acquired aerospace components

Companies that obsess over finding the "next big thing" often:

• Waste resources on unrealistic moonshots
• Neglect their core businesses
• Underperform more focused competitors

Successful companies balance innovation with a strong focus on operational excellence and near-term commercial outcomes.

5. Talent management alone isn't enough; systems empower average employees

Every company can't have the best people. Someone has to be average; in fact half of the companies by definition have to have below-average talent.

Systems elevate everyone. While attracting top talent is important, relying solely on exceptional individuals is not a sustainable strategy. Effective business systems:

• Enable average employees to perform at higher levels
• Ensure consistent decision-making across the organization
• Reduce dependence on a small group of top performers

Successful companies focus on:

• Implementing robust business systems
• Providing clear guidelines and processes for all employees
• Creating a culture of continuous improvement

By empowering average employees to excel, companies can achieve superior results even without having the "best" talent in every role.

6. Operational excellence trumps product differentiation in the long run

In almost every business case we've studied, success over the longer term is more often a function of factory floor excellence than of product differentiation.

Operations matter most. While innovative products can provide a temporary advantage, operational excellence is the key to sustained success. Companies with superior operations:

• Generate higher margins and cash flows
• Can weather economic downturns more effectively
• Are better positioned to invest in growth opportunities

Factors contributing to operational excellence:

• Lean manufacturing practices
• Continuous improvement culture
• Effective supply chain management
• Data-driven decision making

Even in industries with limited product differentiation (e.g., auto parts), companies with exceptional operations consistently outperform their peers and generate superior returns for shareholders.

7. Continuous improvement culture is essential across all functions

The best of the best go beyond the factory floor. They apply systematic tools to all their functions, including R&D, sales, purchasing, distribution, and back office.

Improvement everywhere. Successful companies extend continuous improvement principles beyond manufacturing to all areas of the business. This approach:

• Drives efficiency and effectiveness across the entire organization
• Fosters a culture of innovation and problem-solving
• Enables companies to adapt quickly to changing market conditions

Areas for continuous improvement:

• Research and development
• Sales and marketing
• Supply chain management
• Customer service
• Administrative functions

Companies like Danaher have developed comprehensive toolkits for each function, empowering employees to drive improvement in their specific areas of responsibility.

8. Acquisitions should leverage operational expertise for compounding returns

Systematically leveraging your operational expertise into someone else's business through acquisitions is an incredibly powerful way to compound returns over time.

Acquire and improve. Successful companies use their operational expertise to create value through acquisitions. This strategy involves:

• Identifying underperforming businesses in attractive markets
• Applying proven business systems to improve operations
• Generating higher cash flows from acquired businesses
• Reinvesting in further acquisitions or organic growth

Examples of successful acquisition strategies:

• Danaher's application of the Danaher Business System to acquired companies
• Roper Technologies' focus on acquiring asset-light, high-margin businesses

By consistently improving acquired businesses, companies can create a powerful engine for long-term value creation.

9. Incentives must align with long-term value creation

Incentives have to be tailored to the current needs of an organization—and then evolved over time.

Align incentives carefully. Effective incentive structures are crucial for driving desired behaviors and outcomes. Key considerations:

• Incentives should support long-term value creation, not just short-term results
• Metrics must evolve as the company's strategy and market conditions change
• Incentives should encourage collaboration and system-wide optimization

Examples of effective incentive structures:

• Focusing on return on invested capital rather than just revenue growth
• Tying compensation to customer satisfaction and quality metrics
• Rewarding cross-functional collaboration and knowledge sharing

Regularly reviewing and adjusting incentive structures ensures they remain aligned with the company's strategic objectives.

10. Voice of the customer should guide innovation and improvement efforts

Voice of the customer is an important tool that is increasingly being adopted by the best companies to drive that very conversation.

Listen to customers. Successful companies prioritize understanding and addressing customer needs. Voice of the customer (VOC) initiatives:

• Guide product development and innovation efforts
• Identify opportunities for process improvement
• Ensure alignment between company offerings and market demands

Effective VOC practices:

• Regular customer surveys and feedback sessions
• Cross-functional teams analyzing customer insights
• Integrating customer feedback into decision-making processes

By consistently focusing on customer needs, companies can avoid wasting resources on unwanted innovations and ensure their improvement efforts deliver tangible value to the market.

Last updated: August 16, 2024