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UNLEASHING THE POWER OF MIDCAP COMPANIES

May 8, 2024 | Article
Zakir Gaibi Mauricio Janauskas Kedar Naik  Mustafa Rakla

Midmarket businesses have vast opportunities to increase their performance and
scale if they reinvent how they work. Here are six keys to successful midcap
transformations.

(5 pages)

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
revenue1Category definitions vary based on market size and level of economic
development.—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.



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.



Zakir Gaibi is a senior partner in McKinsey’s Johannesburg office, Mauricio
Janauskas is a senior partner in the Santiago office, Kedar Naik is a partner in
the Brussels office, and Mustafa Rakla is a partner in the Dubai office.

The authors wish to thank Mosa Barlass, Martin Dervichian, Sebastian Fama, and
Nitika Nathani for their contributions to this article.

--------------------------------------------------------------------------------

This article was edited by Joanna Pachner, an executive editor in the Toronto
office.

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