Midsize companies are the lifeblood of many economies but can often increase their scale and impact by undertaking transformations. In this episode of the Inside the Strategy Room podcast, three experts offer advice on how midcaps can reach a higher level of performance. Zak Gaibi, who leads McKinsey’s Transformation Practice in Europe, the Middle East, and Africa, is joined by Kedar Naik, a senior partner with deep expertise in growth transformations, and Mauricio Janauskas, the managing partner of McKinsey’s Santiago office and the leader of the Transformation Practice in Spanish-speaking Latin America. This is an edited transcript of their conversation. For more discussions on the strategy issues that matter, follow the series on your preferred podcast platform.
Sean Brown: First, how do you define a midcap company?
Mauricio Janauskas: We looked at companies in the range of $200 million to $2 billion in revenues. It’s a broad range because what constitutes as midcap company varies depending on the market’s size and maturity. In some geographies, the low end might be $100 million, while in others we included companies above the $2 billion mark.
Sean Brown: Why do you believe that midsize companies need to undertake transformations?
Mauricio Janauskas: Midcap companies operate in an environment where the pace of change is increasing exponentially. And their performance is important to economies. The roughly 50,000 midcaps in the world account for approximately 30 percent of the global GDP and employ almost 40 percent of the global workforce. In some geographies, such as Asia, Middle East, and Latin America, they represent even higher shares of their economies.
We analyzed midcap companies’ performance, focusing on five sectors: apparel, commodities and chemicals, pharmaceuticals, technology, and semiconductors. We found a significant difference between the companies leading and lagging behind in their sectors, so we studied how to take the underperformers higher and help industry leaders become even stronger and faster. Over the past five years, we have helped more than 800 midcap companies around the world transform their businesses. We also interviewed hundreds of C-level executives and analyzed data on 20,000 companies in this space.
Sean Brown: What do you find to be the biggest challenges that midcap companies face?
Kedar Naik: Seven challenges stand out. The first one is their inability to assess their full potential, typically because their peer sets are not clear. As a result, many midcaps don’t know what best-in-class looks like, making it difficult to set the right bar. The second is being too concentrated in one or two geographies or market segments, which makes them extremely vulnerable to disruptions. The third challenge is a limited leadership bench: most improvement initiatives go through the same three, four, or five key individuals. The CEO of a midcap company once told me, “All these ideas are great, but I have five people who would carry the brunt, so we need to sharply prioritize.”
The fourth challenge concerns governance. Given that many midcaps are family- or private-equity-owned, sometimes there is limited separation between professional management and owners. As a result, governance tends to get muddled, which creates challenges with setting short-term versus long-term priorities and making the necessary trade-offs.
Midcaps also have more limited access to talent, innovation, and capital pools than large companies. Another challenge is the low maturity of their data resources and processes, which leads to decisions being based on experience, judgment, and intuition. Lastly, midcap organizations have little collective experience of living through change programs. A client at a chemical company told me that the company hadn’t done a lean program since the 1980s. That’s more than 20 years of organizational inertia, which leads to a limited appetite for change.
Sean Brown: Are there also benefits or strengths that give midcaps an edge over larger competitors?
Kedar Naik: There are three clear benefits that midcap companies have. One is entrepreneurial and organizational agility; the speed of decision making is significantly faster. Midcaps also have deep expertise because they tend to operate in limited segments. The third one is the culture that these companies have. Employees tend to stay there for longer because they develop deep affiliations.
Sean Brown: What have you found to be the key factors that can enable midsize companies to transform into top performers?
Zak Gaibi: First and foremost is setting a bold aspiration and purpose. What we mean by purpose is, what is the story that you would tell the organization about why you are transforming? It can’t be a simple cost-cutting mission or an attempt to improve EBITDA. People need to understand the purpose. This is especially important in companies with social missions. Healthcare companies we work with would lose people if their aspirations were all about profits. The aspirations also have to be based on the company’s true potential. As Kedar pointed out, one of the pitfalls midcap companies face is that sometimes they don’t know what is possible.
Sean Brown: How should companies go about setting that collective bold aspiration?
Zak Gaibi: At least a few core members of the top team need to commit to the journey of taking the institution to the next level. If that ambition isn’t there, you can do the best benchmarking and nobody will care. The second part is getting a fact base around the potential. The best midcaps take a few weeks to consider, “We think the ambition level should be a 20 or 30 percent improvement. Are we in the right zip code? Is this scary enough?” If that number is not scary, it’s not an ambitious goal but an incremental change.
Mauricio Janauskas: The companies I have worked with look at what peers of similar size in other markets have done. That gives them confidence about what is possible. Creating genuine conviction in the C-suite also helps ensure that everyone in the organization knows why they are doing this and that the aspiration is feasible.
Sean Brown: How do you create this conviction in the broader organization?
Zak Gaibi: You need to break down the ambition into blocks of initiatives that 20 or 30 percent of the organization then works on. If one of the initiatives is changing pricing on major accounts with the goal of getting a $200,000 revenue lift, you can break up the major accounts into segments for which different individuals are accountable but their work ties back to the original target. Mobilizing the organization is how you get real impact. When you create an owner mindset by translating the ambition into specific targets and then corresponding initiatives, you are 4.5 times more likely to succeed at the transformation.
Sean Brown: You mentioned the importance of creating a fact base. What should that fact base cover?
Kedar Naik: There’s an element of data and benchmarking analysis. Another is a transformation index exercise that creates a shared understanding across the organization of how it is performing on various practices and dimensions of impact. One fossil fuel–driven midcap wanted to accelerate its journey toward sustainability, so they benchmarked themselves on various dimensions both internally and externally versus peers. They realized that they were lagging behind the market and used that as a call to action to launch a transformation.
Sean Brown: What other elements go into a successful transformation?
Zak Gaibi: The second element is investing ahead of the curve on talent. Small and midcap companies tend to be cautious about hiring. For example, they’re cautious about investing in generative AI expertise. Yet one of our clients reduced its inbound call volumes by over 60 percent simply by hiring a few individuals who understood gen AI and automating customer service tasks.
Prioritization is also critical. Many organizations have what I call zombie initiatives that they have been working on for years. You need to determine the most important priorities to go after.
Another important element is aligning the incentive structure with the change you are putting in place. Financial incentives are one way, but it’s critical to ascribe value to initiatives that various individuals are driving, so when these projects convert to cash flow for the business, the employees get a certain percentage—something meaningful that makes people feel appreciated. We had one client that gave a relatively junior person who generated a lot of impact a special bonus that helped them pay off their mortgage.
Another type of incentive is leadership attention. Many young employees see a transformation as a great way to get exposure and to rise. We work with a midcap agriculture company whose CEO promoted a few entry-level employees during the transformation. That caught everybody’s attention and proved to be more powerful than financial incentives.
Kedar Naik: I think there’s a third category of incentives, which is emotional. One of my clients told the workforce, “This is going to be the adventure of our lives.” By the end of the decade-long journey, only about 10 percent of people left, because it was an emotional exercise and everybody felt connected to it.
Sean Brown: You mentioned that one of the weaknesses midcaps face is technological immaturity. Could a transformation enable them to not only improve their technology but also leapfrog their competitors?
Kedar Naik: Some companies do that. One client decided to use a transformation to go from a fragmented data set to using digital analytics and generative AI as a way to reimagine their sales engine.
Zak Gaibi: Gen AI has a lot of potential in making customer interactions and service operations more efficient. Industrial companies are earlier in their adoption of gen AI. However, an industrial client recently ran a proof-of-concept test of loading all their maintenance manuals for heavy-duty machinery. The gen AI prototype can tell the technician on the front line when a machine breaks down, “This machine had the following procedure done two months ago, so this is likely the problem. Please do the following.” If they decide to scale this application, it could help them leapfrog competitors on cost. There is considerable room for innovation and experimentation, and I think by the end of the year, you will see a lot more scaling even in the industrial space.
Sean Brown: Given the potential of a digital transformation, what are some enablers to making it a success?
Zak Gaibi: I heard this expression once: “Don’t digitize waste and don’t waste digital.” If basics are missing, don’t worry about getting sexy right away. Once you have the basic infrastructure in place, how do you get the data you want? On that, you can start with small sprints as opposed to having grand visions.
Sean Brown: As companies move along this transformation journey, does governance need to change?
Zak Gaibi: When we work with private equity portfolio companies that are near the exit window, particularly if they’re looking at an IPO, they develop clear transition plans. They need CFOs with public company experience and perhaps different boards. They start planting the seeds quite early. One company we work with brought in a new leader for its AI business unit who has public-company experience because they plan to take the unit public at some point.
Sean Brown: One topic that’s high on many business leaders’ minds is the current geopolitical unrest. How is that affecting midcaps?
Mauricio Janauskas: The fact that midcaps may be less diversified than larger global companies creates a risk. Companies can try to increase diversification into other markets or segments to avoid too much exposure to one market. Also, the actual risk may be lower in some markets these companies know well than the broader perception would suggest, and eventually they could move faster to react when opportunities emerge.
Kedar Naik: In this environment, it’s useful for companies to play out scenarios and stress-test the robustness of their business model in various scenarios. Midcap companies tend to be too operational too fast and don’t take that strategic step back.
Sean Brown: Can you share an example of how a midcap company executed a successful transformation?
Mauricio Janauskas: This company is in the downstream gas space in Latin America, and it faced flat growth and likely disruptions in the coming years. The leaders decided that they needed to reinvent the business. First, they wanted to bring digital across the enterprise, both to the sales side and operations. They moved quickly and in less than two years, digital sales went from 10 percent of the total to 45 percent. They also introduced analytics to improve logistics, manufacturing, and a few other functions, and automated some tasks. This resulted in significantly higher margins.
In addition, they explored new sources of supply, which ended up reducing costs by 20 percent, and looked for new avenues for growth. They expanded geographically, but, more important, they developed new businesses, some of which they launched themselves and others they bought. The company succeeded in reviving growth, both by improving the day-to-day operations and changing how employees work.
Sean Brown: What should be the first steps midcap leaders take? How do you recommend sequencing these initiatives?
Kedar Naik: Once you have done a top-down diagnostic and set the ambition, benchmark your performance. Then tackle initiatives in waves because you likely have a thin leadership bench. You should only push two, three, or four things at a time, and when these projects succeed, they can create a self-funding mechanism for future initiatives.
Zak Gaibi: I would start by coming up with a back-of-the-envelope number—one that would scare me but is still feasible. Don’t try to be the next Google. Then, collect a few proof points to show the opportunity and convince colleagues to go after it. That’s step one. Next, start creating momentum by picking a use case that can show the possibilities and help create conviction.
Mauricio Janauskas: If you are in a growth mode, ask yourself whether you are being too cautious and ignoring opportunity in front of you. Second, make sure you can sustain the change over time. That means building the necessary capabilities in the organization and acquiring the talent that will enable you to scale the transformation.
