I just finished reading “Lessons from The Titans: What Companies In The New Economy Can Learn From The Great Industrial Giants To Drive Sustainable Success”. Yes, that’s the real title, but despite it’s length, the book is actually very good. The authors, former sell-side analysts go through the following companies chapter by chapter in an easy, engaging style:

• General Electric

• Boeing

• Danaher

• Honeywell

• United Technologies

• Caterpillar

• Transdigm

• Stanley, Black and Decker

• Roper

• United Rentals

Their overall premise, is that these companies were the Googles and Amazons of their time, having to navigate a changing landscape, competitive threat, and market upheavals. It would thus be instructive to observe how some stumbled, some survived, and in some cases, thrived through the decades under various different leaders.

I’m struck by the commonalities between the business which managed to achieve outsized success, with little to no fanfare from the media. A focus on cash generation (over accounting profit or financial engineering); operational excellence via following a business system (like Lean, EVA or Six Sigma); the discipline to focus on constant improvements outweighing the need to hire superstars; benchmarking the right metrics relative to peers, other industries or globally; the flexibility to change strategies when it was an unpopular decision (e.g. Honeywell, Danaher); a method for generating and absorbing quality feedback; and finally culture – not as a management buzzword – but rather the output of years of sensible actions, disciplined processes and well aligned incentives set by leadership.

The authors spent a well-deserved amount of time delving into the fact that all of the successful companies implemented some form of business system meant to deliver operational excellence. Regardless of the system that was originally used, over time it evolved into the “company way” of doing things. As a result, these companies seem to be better at sourcing acquisitions (more discipline) and then implementing new acquisitions into the portfolio. This article on Scott Management’s page regarding serial acquirers is by far the clearest explanation of how this shared operational excellence fuels M&A. In their opinion, the 2 most successful models of serial acquirers are platforms and accumulators (see diagram below). Not surprisingly, both models incorporate a shared operational excellence program as an attribute of success.

The “shared operational excellence” theme can be observed in the modern day American versions of the Industrial giants – e.g. Amazon and their now-famous “memo instead of PowerPoints” or “customer-obsession” or Apple and their relentless focus on aesthetic appeal in all of their devices (which has now been copied by many within the industry). Is it critical for a company to generate these unique culture or operational excellence elements in order to be successful? I’m not sure, a company can definitely grow in size and headcount without it, but sustained outperformance seems unlikely without these systems in place.

Why does all of this matter? I think it matters because these are all relatively intangible means of competitive advantage which are almost impossible to discern ahead of time. Rather, modern day accounting which is lagging in nature would only reflect the above via superior margins, cash flow and long term performance after the compounding effects from the disciplined, systemic approach had been practiced over many years. Which means, from the outside looking in, one needs to employ non-standard methods of analysis to determine which companies are poised to succeed in the long term. Especially in a Caribbean context, it’s only through constant dialogue with competitors, customers, current and past employees that an analyst would be able to determine whether the company in question has the required success factors to warrant further diligence.

Indeed, especially in the Caribbean where companies disclose much less than in the developed capital markets (US, UK, Canada, Europe), having a core operational excellence, coupled with the discipline of constant benchmarking and iterative improvement – would make a company a formidable acquirer of niche businesses in the region. One could quickly determine whether a potential target would “fit with the company way” and thus be poised to outperform. Targets which might not be intuitively attractive to other strategics, or don’t currently have the performance to justify a private equity transaction, would be attractive to our illustrative Caribbean company.

Bill Miller (of Legg Mason fame) was once asked to outline his competitive advantage in investing. He replied that there are broadly only 3 advantages one may have: informational, analytical and psychological.

Expanding his response to the entire field of capital allocation – which it could be argued, that running a company is just a series of decisions around resource and capital allocation….similarly any competitive advantage falls within 3 main areas.

• Informational i.e. “I have found out something faster than you have and can exploit that knowledge”.

• Analytical i.e. “Given the same bits of information, I have come to a different conclusion about the state of the world based on superior calculations” and,

• Behavioral / Psychological i.e. avoiding some of the behavioral missteps that others fall into like over-confidence, misaligned incentives, anchoring, envy/jealousy, social proof etc. In my view these are the most enduring and having a core business operating system in place allows a company to avoid many of the psychological errors ahead of time.

Not coincidentally, Michael Mauboussin (also from Legg Mason at the time) can be seen touting the need for a focus on process (within investing) as the source of long term success (see below)

I highly recommend that everyone read the “Lessons from The Titans: What Companies In The New Economy Can Learn From The Great Industrial Giants To Drive Sustainable Success” book. If not to take away the individual lessons from each company – understanding the advantage that a core business system imparts intangibly, psychologically is critical to business success. In fact, given the lack of objective, frequent business data in the Caribbean, the ability to establish a sustained informational or analytical advantaged is reduced even more, thus lending greater importance on the need to manage a company’s behavior through some common system.

Food for thought.