Unleashing the power of midcap companies

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Midsize companies don’t dominate the headlines and investor attention the way corporate behemoths do, but they are the economic engines of many countries and a vital part of the global business ecosystem. The world’s 50,000-plus midcap companies—which we define as organizations with $200 million to $2 billion in revenue1—represent more than 40 percent of the global workforce and account for approximately one-third of most economies’ GDP. These companies play a particularly critical role in emerging markets, where they generate up to half the national GDP and serve as the cornerstones of employment and economic growth.

However, the productivity of small and midsize businesses is only half that of large companies, and lower in emerging economies, according to a new report by the McKinsey Global Institute. Additionally, there is significant variance in performance among midcap peers in some industries. For example, in the semiconductor materials sector, top companies generate double the EBITDA margins of the laggards (30 percent versus 15 percent), while the delta between top and bottom technology distributors is even higher, at 7 percent versus 1 percent (exhibit). This suggests that many midcap companies have considerable room for operational and organizational improvement.

Performance varies significantly among midcap companies in certain industries.

To be sure, midsize businesses face obstacles that don’t equally hamper their larger rivals, such as limited resources and leadership benches, challenges with accessing capital, a tendency toward high regional or segment concentration, and little change-management experience. Midcaps also tend to have less developed technological capabilities, especially in advanced analytics and AI. Today’s complex macroeconomic environment and high geopolitical volatility exacerbate these challenges.

To accelerate their growth and maturity, midcaps thus need to leverage their natural advantages over larger companies. Greater agility and faster decision making, deep market or geographic expertise, and deeper knowledge of and connections with customers are all important strengths, as are their often loyal, long-term employees who are willing to take on new roles. At one company, for example, the call center leader moved to finance and procurement roles as needs arose.

For midcap leaders to ramp up growth and returns, and for others to catch up with their better-performing competitors, transformation is an imperative. Our analysis of 20,000 midcap companies’ financials, along with a review of 800 midcap transformations we have conducted over the past three years and hundreds of conversations with executives, suggests that six factors are critical to getting the full benefits of transformations: setting an ambitious goal, investing in talent early, cultivating an owner mindset, rigorously prioritizing initiatives, basing decisions in facts and data, and leapfrogging competitors in technology.

Set a bold aspiration to galvanize the organization

The first step in any successful transformation is setting an audacious but achievable goal by asking: What is our full potential if we mobilize our people and improve our capabilities? If the resulting target isn’t scary, it’s likely incremental—and thus not ambitious enough. Yet midsize companies often lack the vision to set such high aspirations because they may not fully understand their competitive advantages or what constitutes best in class in their industries. Sometimes, it takes an external spark to ignite the flame of ambition. In the case of one company in the consumer health sector, that spark took the form of an equity analyst calling the organization “a hidden diamond” and wondering why it doesn’t polish itself and show itself to the world.

Aside from being bold, the aspiration needs to be specific and backed by proof points showing how improvements in organizational health, capabilities, and sustainability can boost performance. Additionally, the transformation’s purpose should go beyond bottom-line benefits. One midsize US healthcare company, for example, set the vision of “touching the lives of ten million mothers in the next five years from 0.5 million today.” Businesses in sectors with social missions, such as healthcare or alternative energy, have a particular opportunity to leverage such narratives.

An emotional appeal that resonates with employees can galvanize the organization. When a specialty chemicals company in India set an objective to grow tenfold in ten years, the CEO told staff to think about the transformation as a journey: “This is going to be the adventure of our lives as we take this institution to the next level.” Making the employees feel connected to the effort helped the company retain 90 percent of its workforce through the decade-long transformation.

Invest in talent before you need it

Midcaps struggle to attract top talent because larger rivals tend to offer workers more attractive and lucrative career paths. Midmarket companies also tend to underinvest in talent, taking a cautious approach to building out their workforces. However, it’s important to be preemptive rather than reactive in developing or acquiring the needed capabilities.

Leading midcaps direct their limited talent budgets to areas that can deliver the highest value. Once you know where you want to focus, selectively hire the experts you need and then supplement them with existing employees who show an aptitude that can be developed. One mining services player, for example, identified a handful of engineers with analytical talent whom it wanted to shift to AI work and leveraged two newly hired experts to develop the in-house engineers’ skills.

Given the highly competitive talent market, retention of skilled employees is another high priority. Here, small measures can produce big payoffs. One company gave a special bonus to a young employee who contributed to a successful project to help that employee retire their mortgage—a minor cost for the company but a huge benefit for the worker. The CEO of another firm handpicked for promotion three entry-level employees who had worked on successful transformation initiatives. This personal attention, widely communicated throughout the organization, was a more powerful motivator for the full team than individual financial incentives would have been.

Cultivate an owner mindset among leaders

To groom midlevel managers into future leaders and mobilize their energies within the change program, companies need to align performance incentives with the priorities and behaviors the transformation aims to put in place. Once you set the transformation objectives, break them down into targets and initiatives that individual managers can own, then tie performance bonuses to specific KPIs.

For example, one company looking to transform its pricing organization and structure split major accounts into smaller components and assigned accountability for each to a different manager. Involving a broader cross-section of the workforce in transformation initiatives this way can pay off handsomely: midcaps that do so are 4.5 times more likely to execute successful programs.

Rigorously prioritize initiatives

Prioritization and sequencing of transformation activities is critical for several reasons. First, midcaps tend to have little organizational experience in change management, so tackling initiatives sequentially can ease the learning path. Second, capital for innovation, expansion, or operational improvements is usually in short supply, making it important to put resources toward changes that will deliver the most value. A limited leadership bench also means that a handful of executives ends up overseeing both day-to-day operations and transformation initiatives. Focusing their attention on relatively easy opportunities first not only helps them manage their workloads but enables companies to use cash flows from early wins to fund bigger moves. Such a “pay as you go” approach that implements focused sprints can foster momentum and ensure cash-accretive changes are prioritized.

One payroll software company zeroed in on four themes in its transformation: revising pricing, improving service operations, revamping the go-to-market model, and rationalizing the product portfolio. The leaders then approached the work in waves to build momentum and buy-in within the organization. A revised pricing structure generated some quick revenue gains. Next, improvements in service operations—starting with streamlining existing processes and followed by the introduction of digital tools that produced further efficiencies—led to a 50 percent reduction in service operation costs. These moves created a self-funding mechanism that enabled the company to invest in developing a new go-to-market model and upgrading the sales force’s capabilities. With the new model in place, the company reduced its product portfolio by 40 percent. The result: a 6 percent revenue increase and 35-percentage-point spike in EBITDA.

Implement fact-based decision making

Outdated processes and systems often lead midcap executives to rely on experience and intuition rather than data in making decisions. This brings serious constraints. For example, a chemical company looking to accelerate its growth found that its limited sales data and analytics capability prevented it from assessing where in the sales funnel it was losing clients.

To address such shortcomings, companies can streamline and track critical processes such as performance management, with senior executives reviewing the metrics weekly. This way, leaders get a simplified but data-driven perspective on the operations and can intervene as needed. One sustainability solutions company benchmarked its performance and capabilities across various dimensions, from customer experience and organizational health to operating model and technology, using both an internal assessment and comparison with peers. The results showed that it was lagging behind its industry on several dimensions, findings that helped focus the transformation efforts while serving as a call to action to employees.

Leapfrog larger competitors via analytics and AI

One area where midsize companies tend to have an advantage over larger rivals is lower investments in legacy systems. This can allow them to fast-track adoption of leading-edge technologies and streamlined processes to gain significant efficiencies. Take the case of a midcap that invested in a suite of technologies to scale its sales engine. It deployed AI-powered tools to assist salespeople with lead generation, software that helped them refine and personalize customer value propositions, and automated analytics that recommended sales actions. Together, these tools freed up 40 percent of account managers’ time, which they could direct toward client development and retention.

Innovative midcaps start with a fresh view on their technology needs: If we were to build this process now, what technologies would we use? They then launch a few pilots to serve as proof points before undertaking bigger deployments.

Midsize companies may lack the transformation resources and experience that large corporations have, but their agility and loyal employees can enable them to move quickly. By harnessing these advantages and focusing on the six key steps to successful transformations, midcaps can outperform their competitors and capture their full potential.

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