What separates a good IT services company from a truly great one?
That’s the question we sought to answer when the entire Tercera team recently read (and in some cases, reread) Good to Great: Why Some Companies Make the Leap… and Others Don’t by Jim Collins as part of a firm-wide book club.
Published in 2001, the book explores the characteristics and strategies that distinguish companies that transition from merely good to truly great, using in-depth research on publicly traded companies to uncover the key principles that drive their sustained success.
While there’s no single factor that determines whether a firm will scale to the stratosphere or crash down to earth, there are four principles we believe are especially relevant to the kinds of companies that Tercera invests in: early-stage IT services firms. We highlight these principles and their relevance to IT services business leaders below.
Figure out “who” first, then turn to “what”
The first step to transforming a good company into a great one begins with finding the right people: the “who.” This team then answers the “what.” What should the strategy be? What is required to execute on that strategy?
That’s why one of the top factors that we look for when deciding to make an investment is the founder/CEO’s ability to attract talent that exceeds their own.
For example, most founders are great at sales—after all, they brought on many of the company’s first customers and employees. At the same time, when we see a founder who’s recruited a sales leader who is better at sales than they are, we’re always impressed. Truly great leaders surround themselves with great people who help them make decisions through debate, not dictation.
Truly great leaders surround themselves with great people who help them make decisions through debate, not dictation.
Still, it’s difficult to find the right talent, and placing people in the right roles requires rigor. Here are the top three tips from Collins for solving this dilemma.
- When in doubt, don’t hire. Keep looking instead. While a company will limit its growth if it doesn’t attract enough of the right people, having the wrong people on the bus will have a bigger negative impact.
- When you know you need to make a workforce change, act decisively. But first make sure that the underperformer isn’t just in the wrong role. Maybe they could excel at another job.
- Put your best people in front of your biggest opportunities, not your biggest problems. If the project doesn’t work out, don’t throw the people out with it.
No matter how technical or integrated your company may be, never forget that a business is made up of people. This is especially true in a services business! Finding and retaining the right people needs to be your first priority.
Confront the brutal facts (yet never lose faith)
This can be a tough pill for founders to swallow. Confidence and a bright outlook are key ingredients for taking the leap to found and scale a successful business. Risks are unavoidable, and founders can’t be deterred just because something could go wrong.
Optimism unchecked by realism, however, is equally dangerous. Many founders persevere too long in areas that are detrimental to the long-term health of their businesses because they struggle with quitting. That’s why Annie Duke wrote an entire book, Quit: The Power of Knowing When to Walk Away, on the topic of quitting.
Business leaders need to be able to confront the facts, especially when doing so is uncomfortable, and quitting feels like failure. Collins argues that leaders should maintain a “stop doing” list. This list helps enforce discipline and maintain focus on the core, which we believe increases the probability of building an enduring, great company.
When founders make decisions based on a gut-reaction, rather than facts, they can put their businesses in jeopardy. They may find themselves, for instance, with an unwavering commitment to a floundering independent software vendor (ISV) partner or burning cash to offer services that are not profitable.
That’s why founders and CEOs need to create an environment that not only seeks the truth but also abides by it. To do this, Collins offers four suggestions.
- Lead with questions, not with answers.
- Engage in dialogue and debate, not coercion.
- Conduct autopsies without blame.
- Build red flag mechanisms that turn bad info into unignorable info.
One point that we need to add is that the CFO plays a critical role in confronting the brutal facts. A strategic finance function “can bring objective, data-driven insights to ensure you are planning and budgeting realistically,” writes Philip Gronstedt, a VP at Tercera. The right CFO can also “identify root issues in your key metrics, fine-tune gross margins, and optimize cash.”
Use the Hedgehog Concept
The Hedgehog Concept is about identifying where you will win. Collins believes (and we agree) that businesses thrive at the intersection of three things:
- Knowing what they’re deeply passionate about.
- Knowing what they can be the best in the world at.
- Knowing what drives their economic engine.
Collins calls this intersection the Hedgehog Concept because these animals are simple creatures that do one thing consistently well: curl into a prickly ball to protect the core and deter predators. The Hedgehog Concept is all about finding that level of simplicity in your business. Doing so is an iterative process. In the companies profiled in Good to Great, Collins found that it took an average of four years of disciplined thought and action to figure it out and refine it.
It’s worth reading the book to see how the companies profiled discovered what they had the potential to be the best in the world at. For Walgreens, it wasn’t about being the best drug store, it was being the best at “convenient drugstores.” For Wells Fargo, it wasn’t about being the best global bank, it was being the best at “running a bank like a business, with a focus on the western United States.” For Abbott, it wasn’t about being the best pharmaceutical company, it was “creating a product portfolio that lowers the cost of healthcare.”
Determining what your company has the potential to be the best in the world at requires an honest assessment of the brutal facts. It’s a clear understanding of what you can be the best at, not what you want to be the best at. It’s even possible that the services you offer today may not be it.
Once you recognize what your company has the potential to be the best in the world at, you need to understand the drivers of your company’s economic engine.
All of the companies profiled in Good to Great also identified a single economic denominator that they were laser focused on systematically increasing over time. As Collins puts it, “If you had to pick one and only ratio, “profit per X”, to systematically increase over time, what X would have the greatest and most sustainable impact on your economic engine?” For Walgreens, it was profit per customer visit. For Wells Fargo and Abbott, it was profit per employee.
If you had to pick one and only ratio, profit per X, to systematically increase over time, what X would have the greatest and most sustainable impact on your economic engine?
That is the difference between hedgehogs and foxes. The former are simple and consistent; the latter are sly, crafty creatures that do many things without consistency. Hedgehogs know their core. They know what they are the best in the world at and what drives their economic engine. We invest in hedgehogs.
Accelerate with technology
As technology investors, we find it interesting that Collins made the point that great companies aren’t necessarily the first to a technology trend. Instead, they are the best at using technology. They see it as an accelerator, not a catalyst, for growth. They’re the best at figuring out how it fits and can accelerate their Hedgehog Concept.
We frequently encounter crafty IT service foxes that are the first to every tech trend. These foxes are eager to build out IP or software because they believe it will lead to better margins and multiples at exit. But that strategy doesn’t work if they lack real insight into what drives their economic engine and what they can be the best in the world at.
If you’re an IT services business that aspires to build software for direct monetization, take a pause. It could distract from your core business. As Chris Barbin, Tercera’s CEO, says, “not all services IP is created equal.” Tech that boosts your economic engine, such as accelerators that increase your delivery margins or demo assets that help your firm win more deals, may be a better investment.
Find a way
The market is littered with mediocre services firms. Don’t settle for mediocrity.
If you’re looking to build a great, enduring company, you don’t need to be in the hottest industry. Some of the good-to-great companies in Collins’s book were in bad industries that were under pressure. But they had the right people in place, who had the courage to confront hard truths, while staying true to what made them exceptional. And they reaped the rewards.
We dare you. Be more than good.