Michael E. Raynor is a director at Deloitte Services LP. In his research and client work he explores corporate strategy, innovation, and growth across a wide variety of industries. Michael is co-author with Clayton M. Christensen of The Innovator’s Solution, which was on The Wall Street Journal and The New York Times bestseller lists, and sole author of The Strategy Paradox, named by Bloomberg Businessweek one of the year’s 10 best business books in 2007, and The Innovator’s Manifesto, released in 2011, when the Financial Times called Michael “one of the most articulate and interesting of…strategists.”

His most recent book, The Three Rules: How Exceptional Companies Think, co-authored with Mumtaz Ahmed and published by Portfolio/Penguin Group (May 2013), provides a rigorous, practical way for companies of all types to dramatically improve their chances of success.

Mumtaz Ahmed is Chief Strategy Officer of Deloitte LLP and head of Strategy, Brand & Innovation, and therefore responsible for developing strategies for a broad professional services portfolio and defining Deloitte’s strategic positioning.

Mumtaz’s research focus is on the factors contributing to superior corporate performance. His articles, coauthored with Michael Raynor and others, have appeared in such publications as The Harvard Business Review, Ivey Business Journal, Strategic Management Journal, and Deloitte Review.

Born and raised in Pakistan, Mumtaz qualified as an engineer and an accountant in the UK and joined the Canadian member firm in 1982. He established the consulting practice in the Hong Kong member firm during 1993-1999 and moved to San Francisco in 1999, where he is currently based.

Here is my interview of them.

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Morris: Before discussing The Three Rules, a few general questions. First, there have been several dozen books published in recent years in which authors such as Roger Martin, Chris Brown, and Robert Verganti discuss the relationship between design thinking and innovation. What are your own thoughts about that relationship?

Raynor and Ahmed: Design thinking is one of many types of approaches to making good choices when faced with difficult problems. Our work is intended to address the upstream question, “which hard problems are worth solving.” We’ve concluded that when there is a tradeoff to be made between finding ways to be better or cheaper, or between increasing revenue or reducing cost, go with “better” and “revenue”. Of course, if you can in fact break that tradeoff, that’s best of all – it’s what we call an “innovation” (see The Innovator’s Manifesto). But when constraints are binding, which they frequently are, the three rules are a powerful guide.

Morris: In Tom Davenport’s latest book, Judgment Calls, he and co-author Brooke Manville offer “an antidote for the Great Man theory of decision making and organizational performance”: [begin italics] organizational judgment [end italics]. That is, “the collective capacity to make good calls and wise moves when the need for them exceeds the scope of any single leader’s direct control.” What do you think?

Raynor and Ahmed: Our work did not attempt to uncover the actual decision-making processes used by individual people in exceptional companies. Rather, we inferred the decision-making rules that were consistent with the behaviors exceptional companies evinced. As a result, we’re hopeful that, like Davenport and Manville, we are moving away from the notion that an individual needs to be exceptional in order to contribute to making a company exceptional. The three rules can be applied by anyone, and although they are not guarantees of success, their careful use increases the likelihood of success. More importantly, because they are simple, accurate and generally applicable, they should help with strategic alignment throughout the organization, which is the real payoff.

Morris: Here’s a brief excerpt from Paul Schoemaker’s latest book, Brilliant Mistakes: “The key question companies need to address is not ‘Should we make mistakes?’ but rather ‘Which mistakes should we make in order to test our deeply held assumptions?'” Your response?

Raynor and Ahmed: We wouldn’t disagree with Schoemaker’s claim, but we might elaborate on it. The three rules specify which tough problems are most worth solving, and so they point companies in a specific direction. Once you’re headed in that direction, a company should use those mechanisms that are likeliest to yield the best answer for them. So, like design thinking, the sort of “discovery driven planning” approach (see The Innovator’s Solution) implicit in Shoemaker’s “brilliant mistakes” model are solid contenders for a good way to find a viable answer to the most important questions: precisely how to be “better” and how to drive revenue.

Morris: When and why did you two decide to write The Three Rules?

Raynor and Ahmed: We wanted to understand what drove long-term superior performance. It’s really that simple to say…but it proved enormously difficult to tackle in a way that stood up to the standards of the scientific method as we understood it. We began our journey over a decade ago, and the current project became recognizable about six years ago. We’ve published ten major research articles along the way, and endured any number of frustrations as we’ve tried to make sense of a welter of seemingly conflicting data. It is, in many ways, a genuine relief to have reached this stage of the journey. We see the release of the book, not as the end, but as the end of the beginning. The opportunity now is to see how these ideas stand up to the scrutiny and stresses of real-world application.

Morris: Were there any head-snapping revelations while writing it? Please explain.

Raynor and Ahmed: The lack of any strong correlations between specific behaviors and exceptional performance really surprised us. Our rule #3, “There are no other rules”, was born of that observation, because we actually started our work with the assumption that we would find, say, a strong connection between innovation and exceptional outcomes. But we didn’t – and in the case of innovation, this was especially difficult for me (Raynor) to give up on. But the data just wouldn’t support it. We were also surprised that many senior managers we spoke with did not appear to think of the drivers of their companies’ performances in terms that aligned with the rules at all. To the extent that we could determine why they did what they did, the reasons seemed to us highly idiosyncratic – and we’re back to rule #3 again!

Morris: To what extent (if any) does the book in final form differ significantly from what you originally envisioned?

Raynor and Ahmed: It is a much more technically demanding book than we thought it would have to be. But our hoped-for audience consists of people who are making decisions that will determine, or at least significantly impact, the fates of their organizations. We want our work to affect the choices they make. That means we need our audience to really believe that we are right – or at least, right enough – which in turn demanded that we provide the evidence behind our conclusions, not just the conclusions themselves supported by some illuminating anecdotes.

Morris: Based on the extensive research on which the book is based, what are the defining characteristics of “Miracle Workers”, “Long Runners” and “Average Joes”?

Raynor and Ahmed: Our categories are defined by their performance profiles. Miracle Workers are the top performers, finishing in the top 10% of all companies often enough to be credibly more than just lucky. Long Runners do the same, but in the 60th to 80th percentile of performance. Average Joes have average performance and volatility over an average corporate life span. It was by comparing the behaviors of these companies that we came to conclude that it was the degree to which companies in each category hewed to the rules that the rules were the key determinants of exceptional performance. Miracle Workers follow the rules most closely, Long Runners to a lesser but still significant degree, and Average Joes follow them least of all.

Morris: By what process did you eventually formulate the three rules rather than, say, a covey of seven?

Raynor and Ahmed: It was a long, iterative, and at times painful process. We tried on any number of different ways of addressing the data, and we wrestled with, among other constructs, M&A activity, geographic expansion, innovation, and operational excellence. We settled on the three rules based on their fit with our detailed case studies and the statistical validity of their fit with our full population of exceptional companies. In other words, we tried and discarded alternative hypotheses along the way, settling for “the three rules” construct only because it provided the best fit with our data – which meant not only the best correlations with observed outcomes, but the best claim to specifying the underlying causal connections between behavior and performance.

Morris: To what extent (if any) are these rules counter-intuitive? Please explain.

Raynor and Ahmed: We don’t think any of the rules is counter-intuitive. We could well have concluded that price-based competition was the most likely path to superior profitability, and had that been the case, I think we would have had just as many people saying “I told you so” as we do now, with our conclusion that it’s “Better before cheaper.” The same goes for “revenue before cost”: lots of businesspeople see cost leadership as central to superior profitability, but there are many others convinced of the benefits of investing to create value. That is a big part of why we see the rules as so valuable: they provide a fact-based answer to a problem with two very different, but equally plausible, resolutions.

Morris: Which of them seems to be the most difficult rule for executives to follow? Why?

Raynor and Ahmed: Perhaps rule #3 will prove, in the long term, to be the most challenging, because it demands that a company be willing and able to change any and everything about itself in order to remain aligned with the first two rules. That’s tough, because many of us have rules of thumb that have served us well, yet our advice is to view important decisions through the prism of better before cheaper and revenue before cost – and only those two rules.

Morris: In the first chapter, here is a statement that caught my eye: “We are optimistic because the three rules are measurable and hence actionable. Whether you are establishing a position based on greater non-price value than your competition is something that can be measured today.” Please explain.

Raynor and Ahmed: Too often, business books offer advice like “have a clear strategy.” How are you supposed to know, really know, if your strategy is clear? After all, who sets out to create an “unclear” strategy? In contrast, the price you are charging can be quantitatively compared with the prices being charged by your competition. You can know, really know, if you’re the price leader or if you are charging more. You can measure the quality of your solution versus your competition’s – do you deliver on time compared to them? is your product more durable than theirs? do you provide greater selection? – and know whether or not you are better. That means you can know in quantitative terms, independently of your performance, whether or not you are following the rules.

Morris: Please explain the meaning and significance of Chapter 2’s title, “Finding Signal in the Noise.”

Raynor and Ahmed: When seeking to study exceptional companies, you need to know first of all if you’re actually studying companies with exceptional performance. So, how well does a company have to do in order to be heard above the roar generated by the variability of performance in a competitive and dynamic environment? That’s not a question that had been asked before, or answered in a way that applied to the study of company performance. So we set about to develop a way to find the “signal” – company-level performance – in the “noise” – the rough and tumble of the system within which companies must compete.

Morris: What specifically differentiates your three rules from others, notably those in other business books such as In Search of Excellence, Good to Great, and What Really Works?

Raynor and Ahmed: The two most important differences, we hope, are how we selected our sample and how we created connections between behaviors and performance. In the first instance, we developed statistical tools to identify those company that were good enough for long enough that we could be highly confident that the companies we studied were in fact more than just lucky. When we applied this method to the populations studied in other research we found that most of the time their allegedly successful companies were indistinguishable, on the basis of their performance, from lucky random walkers. Second, we identified the underlying financial structure of the performance differences we had to explain. For example, we were able to identify if a company was generating superior profitability through higher gross margin percentage or higher asset turnover. Consequently, we were forced to identify behaviors that drove those dimensions of financial performance. This gave us a great deal of confidence that we were able to identify the differences that made a difference.

Morris: In the final chapter, “Defying Gravity,” you and Mumtaz say that attempts to provide advice on how to be a “great” or “exceptional” company are “subject to an irony that borders on a paradox”. Please explain.

Raynor and Ahmed: Whether or not a company is “great” or “exceptional” is a function of its relative performance, that is, how well it does compared to other companies. Doing better than other companies means doing something different. Yet advice on how to be different that is universally adopted would lead all companies to be the same, and so none of the companies that took the advice would enjoy superior performance. So, if the advice is right, and everyone takes it, no one will be “great”, and so the advice is wrong! To some extent, this criticism overstates the case, but the deeper point is that our rules are not really subject to this paradox.

The rules are not specific instructions on how to be an exceptional company. They are not a “map” with turn-by-turn instructions on how to get from wherever you happen to be to exceptional profitability. They are instead a compass, a tool to point the way in which you should be headed over time. It falls to each company to chart its own course, and each will find its own unique path to better before cheaper and revenue before cost.

Morris: For more than 25 years, it has been my great pleasure as well as privilege to work closely with the owner/CEOs of hundreds of small companies, those with $20-million or less in annual sales. In your opinion, of all the material you provide in The Three Rules, which do you think will be of greatest value to leaders in small companies? Please explain.

Raynor and Ahmed: Our hope is that the rules themselves will prove illuminating and useful to leaders in companies of all types. The principle of competing based on being “better” than the competition rather than “cheaper” seems to us to be universally applicable, from the corner dry cleaner to a multi-billion dollar multi-national; so, too, with our prescribed emphasis on revenue rather than cost. The rules are few in number, easy to remember, quantifiable, and actionable. They are a compass that anyone can use to help them make difficult decisions of pretty much any kind. We would welcome feedback from entrepreneurs and those leading smaller companies as they find ways to use the rules to create the futures of their businesses.

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They cordially invite you to check out the resources at this website.