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The Best Performers


Historically, auto insurers were never known as a customer-friendly bunch. Then came Progressive Corp. (PGR). The Mayfield Village (Ohio)-based insurer first turned heads in the 1990s by giving prospective customers price quotes from up to three rival insurers, as well as its own -- a provocative move that won thousands of new accounts. Progressive further endeared itself to drivers by mobilizing an army of 12,000 claims adjusters who sped straight to an accident scene -- and often cut a check right on the spot.

For some insurers, that might be enough. But Progressive has never stopped trying to find ways to do things better, faster, and cheaper for its 12 million customers. "When you stop evolving, you've got a real problem," says Progressive's chief executive, Glenn M. Renwick. "We're always asking, 'Is there an even better way?"' So last April, the $11.9 billion insurer rolled out a new service that lets drivers involved in a small accident drop off their banged-up car, pick up a rental -- and then come back to a fully repaired car a couple days later. So far, Progressive's bold gambits have paid off big: While other parts of the industry are just pulling out of a funk, Progressive's profits have soared an average annual 183% over the past three years, to $1.3 billion in 2003. That, along with strong revenue gains and a robust 152% return on its stock since 2001, has enabled Progressive to claim the top spot in the 2004 BusinessWeek 50.

Progressive epitomizes the spirit found among the companies in the magazine's eighth annual ranking of the best-performing members of the Standard & Poor's 500-stock index. Granted, our list is dominated by companies that were well-positioned to profit from the economic recovery -- health-care outfits, homebuilders, and resurgent technology companies, as well as retailers that have benefited from the resilience of the American consumer. "On one level, it's pretty remarkable how well the [BW50] reflects the broader macroeconomic trends," says Adrian J. Slywotzky, a managing director at Mercer Management Consulting Inc. But scratch beneath the surface, and you'll find something more -- namely, that many of this year's stars have a deeper understanding than rivals of what makes their customers tick.

The Class of '04 ranges from companies like Lowe's Cos. (LOW) (No.9), which sensed the importance of marketing its home-improvement wares to the women who actually make the majority of home renovation decisions, to Dell (DELL) (No.16), which has built a cult following among corporate information technology managers for its low prices, certainly, but also for providing customers with the data to better understand their own purchasing and usage patterns. And at a time when many corporate managers complain that they have no pricing power -- a symptom of weak brands -- this year's BW50 also includes a number of power brands like eBay (EBAY) (No.13), Starbucks (SBUX) (No.25), and Harley-Davidson (HDI) (No.43) that aren't so much selling products as they're selling lifestyle choices for consumers worldwide.

The Quest for the Best

When these companies expand, it's less through debt-financed acquisitions than through well-planned diversifications around their core business. Consider the success that 3M Co. (MMM) (No.47) is enjoying after finding new applications for some of the optic films that it developed back in the 1960s. While the technology was originally developed for use in overhead projectors, 3M's scientists have modernized it to create clearer and brighter pictures in the LCD screens used in everything from mobile phones to TVs. These companies "have learned that it's easier to grow using an electron microscope than a telescope," says Chris Zook, head of management consultant Bain & Co.'s worldwide strategy practice. Brand extensions will take you only so far, though. Some of this year's BW50 companies have consistently demonstrated an ability to cut costs and boost productivity by reengineering the ways they do business.

Unlike other lists, the BusinessWeek 50 is not an exercise in tracking which companies are the biggest or have the hottest stocks. Rather, we built the BW50 to distinguish the largest companies that can go the distance with strong operating and market performances. To determine the winners, we run a proprietary screen that's designed to measure growth in revenues, profits, and returns to shareholders, and to do so over both one- and three-year periods. We also examine net margins to see which companies are wringing the biggest efficiencies out of their operations, and we analyze debt levels to make sure companies aren't simply buying their growth through debt-financed acquisitions. And to level the playing field for larger companies -- which would have a hard time matching the percentage gains of their smaller brethren -- we weight the results in favor of sales volume. The result: a ranking of companies that symbolize the best in Corporate America, both in operational performance and in their ability to convert that success into lucrative gains for shareholders.

Changing of the Guard

But if there's one constant in the BusinessWeek 50 over the years, it has been the amount of turnover. In part, that reflects recent roller coaster-like swings in sectors such as energy, tech, telecom, and retailing. Altogether, only 20 companies from the Class of '03 are making a repeat appearance on the 2004 roster. Of the 30 newcomers, two of this year's best performers, Symantec Corp. (SYMC) (No.15) and Express Scripts Inc. (ESRX) (No.42), were added to the S&P 500 during the past year. Of the other companies, there's no mistaking the importance of catering to customers: The BW50 includes three homebuilders and eight retailers -- the most merchants in BW50 history. Reflecting the resurgence of Silicon Valley, six technology companies made the list, vs. three last year. That's still a far cry from 1997, when our inaugural ranking was dominated by 12 tech companies, including the top four: Intel (INTC) (which rejoins the list this year after a three-year absence), Microsoft (MSFT), Dell, and Cisco Systems (CSCO).

This year's list also includes nine health-care and drug companies -- a relatively impressive showing, albeit a sharp drop from the 16 on last year's list. The culprit: a decline among pharmaceutical makers, who have suffered from patent expirations and a dearth of blockbuster drugs. Indeed, with Merck's plunge from No.20 last year to No.270, the last surviving company to make the BW50 every year since inception has been dethroned. To some extent, this turnover reflects the measurement periods -- one and three years -- that BusinessWeek uses in determining the rankings. Capturing data over more than three years might cut down on the churn -- but it would risk missing the dynamic nature of the most creative companies.

Of course, what many readers will want to know is simply, can you make money by investing in the BW50? That depends on how you use it. As a basket of stocks, the group made money last year, but less than if you had invested in one of the major indexes. The Class of 2003 delivered a 22.9% total return during the 12 months ended this past Feb. 27, which is the cutoff date we use for calculating one- and three-year total market returns. That compares with 34.1% for the Dow Jones industrial average, 36.1% for the S&P 500, and a blistering 51.8% rebound by the tech-heavy NASDAQ Composite Index. However, the BW50 also provides a wealth of data that can be used as the starting point for investment ideas. For one approach to slicing and dicing the list, check out Robert Barker's column on page 94. To track the market performance of the new list over the coming year, go to the Figures of the Week page online at www.businessweek.com/magazine/extra.htm.

Growth Gains on Value

This marks the fourth straight year that the BW50 has trailed at least two of the three major indexes, which reveals something that should be obvious from the way we compile our ranking: The BW50 is at heart a growth list. As such, it tends to outperform the broader market during periods when the economy is sizzling but is prone to lagging behind when the economy is either in recession or is revving back up as it did in the past year. Indeed, most growth indexes have had a hard time during that same stretch: Over the past four years, the Russell 3000 Growth Index suffered an annualized 12.1% decline, while the Russell 3000 Value Index gained an average 7.2%. "It's been an abysmal time for anything that looks like growth," notes Kevin M. Johnson, a principal at Philadelphia-based Aronson+Johnson+Ortiz LP, a $15 billion investment firm that uses quantitative analysis. Johnson thinks the performance gap between growth and value is likely to narrow, or even reverse, in coming years, given that the "earnings yield" between most growth and value indexes has narrowed.

It might be tempting to discount the accomplishments of so many consumer-oriented companies on the BW50, given how well consumer spending has held up. Or to see the seven energy companies on the list as proof that success in this sector depends on nothing more than the price of oil -- which rose 23% last year, while natural gas prices soared 70%. And there's no denying that the sharp drop in mortgage rates contributed to the high rankings of homebuilders like Pulte Homes Inc. (PHM) (No.11) and Centex Corp. (CTX) (No.12).

But somehow these outfits rise above the rest in their industries. Why? Behind every BW50 success story there's usually a company culture that encourages more one-of-a-kind products or proves more adaptable than rivals. So while it's good to be in the medical-equipment business at a time when the population is aging, that doesn't fully explain why St. Jude Medical Inc. (STJ) (No.21) and Stryker Corp. (SYK) (No.30) boast average annual profit growth of 40% and 27%, respectively, over the past three years. Led by longtime CEO John W. Brown, Stryker has consistently stayed one step ahead of the competition in hip- and knee-replacement products. That includes last year's Trident -- the first ceramic-and-titanium replacement hip, which can last a lifetime instead of the usual 10 or 20 years for a polyurethane device. St. Jude, meanwhile, pumps a hefty 12.5% of its revenues into research and development. It's now reaping the fruits of those investments with insatiable demand for its implantable defibrillators, following independent studies showing those devices significantly reduce deaths in patients with even mild heart disease. "It's a large, thirsty, needy market, and we've got critical mass and great momentum and tremendous product flow. The rest kind of flows naturally," says CEO Terry L. Shepherd.

Targeting the Right Customer

Some of the other health-care companies that dot the list are prospering from their ability to bring marketing skills to a sector that isn't known for its consumer savvy. For instance, while most HMOs complain of a cutthroat environment caused by declining reimbursements, this year's BW50 contains three managed-care providers -- WellPoint Health Networks (WLP) (No.3), UnitedHealth Group (UNH) (No.4), and Humana (HUM) (No.50) -- that have demonstrated a Procter & Gamble (PG)-type touch. "P&G takes a commodity like laundry detergent and creates different products and price points, and these companies have brought the same consumer marketing tactics -- different products and price points -- into health care," notes Russ Hagey, a managing director at Bain.

Consider WellPoint, which was one of the first companies to pioneer flexible health plans. Today, the Thousand Oaks (Calif.)-based company offers its 15 million medical members a variety of flexible plans, including FamilyElect, which allows different members of a single family to elect different levels of coverage. That means a mom might have a preferred provider organization that offers the highest level of choice with high deductibles and co-pays, while her healthy teenage son uses a less pricey HMO. WellPoint also provides its members with a trove of helpful information, including Internet sites that let individuals see quality ratings and average costs for many common procedures performed at network hospitals. The upshot: Members are happy, and the customized coverage helps lower costs for their employers -- making them happy as well. "Traditionally, health insurers took a mathematical approach to addressing risk," notes CEO Leonard D. Schaeffer, who will be chairman of the company formed when WellPoint merges into Anthem Inc. this summer. "But it's not about math. It's about understanding what consumers want."

The key test for many of the companies that rode the economic cycle upward, of course, comes when the worm turns and they lose pricing power. But for every energy company that made the BW50 thanks to surging oil and gas prices, there are many other companies that now seem impervious to the vagaries of the economy thanks to their success at creating an aura around their brand. Overall coffee sales remain relatively flat in the U.S., for instance, but Starbucks Corp. has shown an amazing ability not only to charge a premium price for its drinks but also to get customers to pay up for music CDs, board games, and other products that are perceived as part of the Starbucks lifestyle. Similarly, Harley-Davidson Inc. cashed in on its 100th anniversary last year by releasing several limited-edition bikes that were snapped up by its loyal fans, and dealers still charge hundreds over sticker price for the most popular bikes, like the Road King or Fat Boy. These companies know better than anyone how quickly today's "it company" can become tomorrow's has-been. "We stay ahead of the game by worrying about everything that could happen," says Jeffrey L. Bleustein, CEO of Harley-Davidson.

Given the deflationary pressures that leave many businesses unable to raise prices, management experts say it's more important than ever for companies to know which of their customers are the most profitable -- and have the potential to tap them for even greater profits in the future. That isn't necessarily news. In marketing circles, many strategists have long believed that 80% of a company's profits come from 20% of its customers. "What's new is companies' ability to identify who the 20% are," says Frank Mulhern, a marketing professor at Northwestern University. Thanks to their growing use of sophisticated software, Mulhern notes, smart companies "are able to target the exact customer and the revenue that they're generating per person." Consider Starbucks' "Duetto" Visa card, which combines stored value with a credit card that customers can use to earn special offers and accrue points. The program enables Starbucks to drive traffic by targeting special discounts and promotions while it builds a database of the purchasing habits of its most profitable customers. That's a big reason the company has generated annualized 37% profit gains over the past three years.

"One Transaction at a Time"

For Lowe's Stores, the revelation from customer research that roughly 80% of home-improvement decisions are initiated not by men but by women prompted the chain to rethink the traditional hardware store. In addition to the bins of nails, hammers, and drills, a typical Lowe's store stocks everything from Laura Ashley throw rugs to Michael Graves-designed faucets. At the same time, Lowe's knows that stocking its store with trained, full-time help rather than part-timers ensures that these shoppers get the professional advice they need -- and often walk out the door with more than they came in for. While most other retailers employ as much part-time help as possible to keep benefits costs down, fully 80% of Lowe's store workers are full-time. "No matter how great your vision or strategy is, you have got to be out there to be able to meet customer's needs, one transaction at a time," says Lowe's president, Robert A. Niblock.

Ditto for Staples. When Ronald L. Sargent took over as CEO of the office-supply retailer in early 2002, it looked as if the onetime growth company had hit a wall. Sargent conducted intensive customer research and decided that the chain was attracting Wal-Mart's (WMT) typical customer, a casual shopper just shopping the occasional sale. Says Sargent: "They might buy a computer from us, but the problem was that we didn't make much money on it." So instead, Staples homed in on small businesses, which it realized were producing 65% of sales -- and 90% of profits. It revamped the product mix and gave clerks the training to provide small-business owners with useful advice. The payoff? While some other office-supply retailers are reporting slumping sales at older stores, Staples saw sales at all stores open a year or more rise 4% last year.

In today's slower-growth environment, companies constantly need to find new ways to wring out costs as well. Many of the BW50 companies have been leading the productivity charge. Home Depot Inc. (HD) (No.22), for instance, added automated "self-checkout" lanes at nearly 800 of its 1,707 stores. It also armed cashiers with cordless scan guns, helping to shave 8% off the average checkout time, and the use of self-checkout has enabled Home Depot to redeploy workers back onto the sales floor. A companywide crusade by Dell to rethink every business task enabled the PC maker to slash its annual costs by $3 billion. At its Nashville plant, Dell has automated parts-picking, software loading, testing, and boxing of new desktop PCs -- everything except the actual construction of computers. Dell came away convinced that it can eventually triple the plant's output with just half the number of workers on the factory floor.

While it's far too early to declare victory, there's another area where companies seemed to exhibit more discipline this year: accounting. For the prior two years, we had "deranked" several companies, such as WorldCom in 2002, that otherwise qualified for the BW50 but whose accounting practices were known to be under federal investigation. This year, no company suffered that fate. The only known investigation involving one of the BW50 companies is a probe by the U.S. Attorney in Boston of Stryker's billing practices at its physical therapy centers. Stryker says it is cooperating fully with the investigation.

That may be a sign that more companies are using simpler accounting and making it easier to judge the quality of their earnings. And there is some encouragement in this year's BW50 for those attempting to scrub away the taint of scandal. Cendant Corp. (CD), formed by the 1997 merger of franchising company HFS Inc. and direct- marketing firm CUC International Inc., uncovered a $500 million accounting fraud in the businesses of the former CUC back in the late 1990s. But six years later, Cendant has claimed the No.2 spot on the BW50. Cendant took a back-to-basics approach. Management brought a number of off-balance-sheet entities back onto Cendant's books and has done very few deals over the past 18 months. Cendant CEO Henry R. Silverman made good on his pledge to use cash flow to institute a dividend, cut debt, and buy back shares. "The overarching objective was to prove that Cendant was more than an acquisition-driven company [and that] we can grow organically," says CFO Ronald L. Nelson. The stock has moved in concert: In the 12 months ended Feb. 27, Cendant's shares returned 85%.

This year's BW50 companies struck gold by digging deeper than their competitors. They stand out for their endless quest to serve their customers better, whether it's getting to the scene of an auto accident quicker, providing more clerks on the sales floor, or simply pouring a better cup of coffee. It's a frame of mind, says John M. Barth, CEO of Johnson Controls Inc. (JCI) (No.38), the lone auto parts supplier to make it into our ranking: "Long ago, we realized that if we were going to grow and improve our bottom line, the first thing we had to do was help our customer grow and improve his bottom line." He adds: "We don't delegate customer relations. That's first and foremost everyone's job." That sort of attention to detail is one asset that never loses its value. By Dean Foust in Atlanta, with Fred Katzenberg in New York, Brian Grow in Atlanta, Joseph Weber and Michael Arndt in Chicago, Amy Barrett in Philadelphia, and bureau reports


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