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The Best Performers


COVER STORY PODCAST

When it comes to anticipating fashion trends, many apparel makers rely on the intuition of a charismatic designer like Ralph Lauren or a savvy executive like Mickey Drexler. But not the folks at Coach Inc. (COH). Every year, the New York maker of women's handbags assiduously interviews more than 60,000 of its customers through Internet questionnaires, phone surveys, and face-to-face encounters with shoppers at the 300 stores. Such intense market research has helped Coach executives spot trends well before the herd, and this in turn has helped it to extend the brand far beyond the leather bags that long were its trademark and into watches, accessories, and clothing. After hearing customers complain that they couldn't find decent carry-on luggage for weekend getaways, for example, the company in July, 2006, launched its "Signature Stripe" travel bags--a new line that accounted for a hefty 15% of Coach's sales of full-priced merchandise during the first month out of the gate.

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That ability to peer around corners ahead of competitors has paid off big for Coach shareholders: Sales have grown an average of 29% over each of the past three years, fueling a strong 63% averaged return on invested capital during the same period. Such stellar performance was enough to earn Coach the No. 2 spot in this year's BusinessWeek 50, our 11th annual ranking of the best-performing companies in the Standard & Poor's 500-stock index. "This research gives us a real competitive advantage," acknowledges Coach Chief Executive Lew Frankfort. "The only way for us to grow on a sustained basis was if we evolved as our consumers evolved."

Companies in the BusinessWeek 50 represent our choices as the "best in class" from each of the 10 sectors that make up the S&P 500. To select this year's star performers, we first ran companies through a proprietary screen that we refined this year to emphasize two measures--how well each company's management has been using the capital at its disposal and sales growth. We also chose only the best performers from each sector, to ensure that we were rewarding true management excellence and not just the ability to ride the wake of a hot sector. And to provide the wisdom, perspective, and common sense that computers can't, BusinessWeek's editors and reporters reviewed each company on the list, making a limited number of changes where necessary.

OUTSTANDING CLASS

The result may be one of the strongest groups of companies in the 11 years that we've conducted this annual search for the best performers. The Class of 2007 is chock full of companies that are rewriting the rules of engagement in their industries. They are the agitators, the pioneers, and the game changers that are leading the way in the 21st century. Case in point: This year's top performer, Google Inc. (GOOG), is using the same mastery of algorithms that enabled it to dominate Internet search to launch innovative new services, including one brokering advertising for traditional media. The rankings also include dynamic companies such as Nucor (NUE) (No. 4), which has deployed technology and cutting-edge employee-incentive programs to stand the steel industry on its head, and Apple (AAPL) (No. 34), which is trying to revolutionize cell phones in the same way it did music players.

Our screening also produced the names of smaller companies playing at the top of their game, such as Rockwell Collins Inc. (COL) (No. 24) and Varian Medical Systems Inc. (VAR) (No. 14). They're joined by outfits ranging from Best Buy (BBY) (No. 32) to payroll manager Paychex (PAYX) (No. 40) to Black & Decker (BDK) (No. 45). What distinguishes many of these organizations is a deep understanding of customers, a competitive advantage that has enabled them to sell more goods and services than rivals.

Best Buy, for example, recognized that computer buyers were nervous about fixing their desktop machines and developed its popular Geek Squad home PC repair service. For Paychex, a tight bond with customers has enabled it not just to manage payrolls for its small-business customers but also to provide tax services and benefits consulting. This type of constant innovation is increasingly critical for companies, given the shrinking lifespan of business plans. Chris Zook, head of the global strategy practice at Bain & Co. and author of the forthcoming management book Unstoppable: Finding Hidden Assets to Renew the Core and Fuel Profitable Growth, says his research shows that the average "shelf life" of business strategies has shrunk by roughly 50% over the past 15 years. The reason? "Globalization. Capital moves faster, and differentiations are harder to defend," he says. "But companies that are able to extend their franchise are able to achieve a new surge in growth, which is one of the hardest acts in business."

Zook points to United Parcel Service Inc. (UPS), which clocked in at No. 33 in this year's rankings. With its basic business of delivering packages turning into a mature business growing in the mid-single digits, Atlanta-based UPS conducted extensive customer research that revealed that many of its corporate shippers were looking to offload the chore of managing their supply chains, which would free them to focus on their core businesses. So UPS went on an investment binge that today enables it to do everything from managing warehouses for customers to helping run clients' entire global transportation network. For some customers, it even handles repairs: If you own a Toshiba Corp. (TOSBF) laptop that needs fixing, Toshiba provides an 800 number that's actually manned by UPS, which dispatches a UPS driver to pick up the broken laptop for shipping to a UPS warehouse in Louisville, where UPS-trained technicians fix it before shipping it back, via UPS, of course. That diversification has enabled Toshiba to focus on its core business of designing and building computers, and helped UPS boost its sales an average 13% over each of the past three years. "UPS is not just a transportation company anymore. It's an information technology company focusing on transportation," says David Simchi-Levi, a professor and supply-chain expert at Massachusetts Institute of Technology. "There is going to be a lot of demand for such services, and UPS is perfectly positioned to deliver them efficiently."

STAYING FRESH

Inevitably, powerful macroeconomic forces helped shape this year's BW 50 rankings. The Class of 2007 includes a number of energy companies that are basking in the sharp rise in oil prices over the past two years: Sunoco (SUN) (No. 6), EOG Resources (EOG) (No. 20), Valero Energy (VLO) (No. 36), and xto Energy (No. 49). And the housing boom taking place in recent years helped give a lift to a number of companies on the list, including Bed Bath & Beyond (BBBY) (No. 15), Sherwin-Williams (SHW) (No. 22), and even Moody's (No. 29), which has enjoyed a booming business providing credit ratings for the trillions of dollars of mortgage-backed securities issued by Wall Street. (To avoid perceptions of favoritism, we excluded BusinessWeek's parent, The McGraw-Hill Companies (MHP), from the rankings, even though its performance would have earned it a spot in the top 50.)

If there's one common trait among these companies, it's the degree to which these companies don't take their success for granted. Truth is, many work hard to anticipate and head off potential problems well before outsiders are even aware of these looming challenges. That's the case at Starbucks Corp. (SBUX) (No. 28, its fourth consecutive appearance), where founder and Chairman Howard Schultz recently sent other executives a memo--leaked by an employee to a Starbucks blog--questioning whether such labor-saving initiatives as having baristas use automatic espresso machines was leading to what he called the "commoditization" of the Starbucks experience.

Fearful that the tech services market will one day revolve around price and price alone, Cognizant Technology Solutions Corp. (CTSH) (No. 12) CEO Francisco D'Souza is feverishly working to ensure that he differentiates his services from what is offered by competitors. To that end, Cognizant has begun hiring mbas who are experts in banking and other industries to work with customers such as JPMorgan Chase & Co. (JPM) onsite to help tailor Cognizant's service to each client's specific business. And it is constantly adding higher-value services--everything from testing new software to implementing the sprawling software platforms developed by the likes of SAP (SAP) and Oracle (ORCL). "We have to be constantly focused on staying fresh in the eyes of our customers because the [info-tech service] companies who do nothing won't be there long term," says D'Souza. That strategy has paid off in spades for Cognizant shareholders, who have seen shares rise 57% over the past year.

What BW 50 companies share is an unshakable passion for excellence. This year we've selected a handful of our star performers to profile: Allegheny Technologies Inc. (ATI), a producer of specialty metals that's doing a brisk business selling to the resurgent aircraft manufacturers; Oracle, which has expanded its software suite through a flurry of acquisitions; and commercial broker CB Richard Ellis Group (CBG), which is helping real estate developers fill all those gleaming new office towers going up around the globe. We also took a look at Lehman Brothers Inc. (LEH), which has moved far beyond its roots as a bond dealer to become a force in M&A, and Stryker (SYK), whose artificial hips and knees have become the rage among aging boomers.

To round out this year's package, we've included brief snapshots of each of the BusinessWeek 50 companies as well as statistical tables that provide rankings for each of the year's best performers.

By Dean Foust, with Michael Mandel, Frederick F. Jespersen, and David Henry in New York


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