US midsize industrial companies are renowned for their distinctive technologies, widely recognized products, and strong brands. But in terms of performance, they could do a lot more. If they realize their full potential, they could collectively boost US GDP by $275 billion to $460 billion and add up to 1.5 million jobs by 2030, a McKinsey Global Institute analysis shows. What’s more, by raising their profiles and performance, they could stimulate new investment, encourage government programs, and attract much-needed talent to address the labor shortages that threaten their growth.
Change is imperative because many midsize industrials (those with less than $2 billion in revenue) are feeling the heat amid uncertain growth prospects and geopolitical turbulence, which are having drastic impacts on supply chains. In addition, they face several structural headwinds to growth, including a lack of scale, limited access to the best talent, high levels of fragmentation (both physical and digital), and often dispersed digital and analytics architectures—all of which require concerted action.
The current macroeconomic and business environment presents midsize industrials with challenges but also opportunities. That is, if they can take bold action on transformation and adopt through-the-cycle thinking—as described in this article’s seven key steps—they can build on their roles as linchpins of growth and employment and achieve significant uplifts in performance. Indeed, our research shows that if midsize companies get transformation right, they can outperform large-cap companies by a significant margin. If they fail, however, they are likely to suffer more than their larger peers. The lesson, in short, is that the transformation stakes are about as high as they can be (Exhibit 1).
Four structural factors inhibiting midsize performance
Midsize industrials often struggle to achieve significant change without embracing new ways of thinking and operating. Indeed, many corporate leaders already understand that successful change programs must be predicated on a bold vision of what the organization could be if it realized its potential. But before they embark on that journey, they must get a grip on four structural factors that often limit their performance:
- A lack of scale. Midsize companies often compete as “one of many” and are up against players with significantly deeper pockets to invest in innovation, digitization, and other value adds. Moreover, limited scale constrains their negotiating power with both suppliers and customers, affecting their ability to drive value through procurement and pricing. Finally, they face continued threats from low-cost competitors, which can undercut them on price and, in doing so, shift entire competitive ecosystems.
- Fragmented operations. Midsize industrials are often bolted together from a series of M&A transactions, which have enabled them over time to enter new verticals or acquire new product lines. As a result, they are often saddled with dead weights that include cumbersome product portfolios (as many as tens of thousands of SKUs, often with redundant or duplicative characteristics), fragmented operational footprints, and dispersed organizational structures. Common challenges include business units failing to connect on commercial opportunities, high operational complexity, and limited economies of scale.
- Dispersed digital and analytics architecture. Midsize companies tend to operate with dispersed enterprise resource planning (ERP) and IT systems—again the result of historical acquisitions—alongside inadequate data infrastructure, underdeveloped analytics functions, and weak reporting processes. They fall short in developing a 360-degree view of their own performance or of market opportunities. As a result, they fail to maximize their potential—for example, failing to optimize pricing, capture aftermarket entitlement, or achieve optimal agreements with suppliers.
- A talent deficit. Midsize industrials often struggle to attract the best talent, reflecting a lack of competitive career progression opportunities and lower compensation offers than their larger peers. One cause is a long-term lack of investment in attracting, developing, and retaining talent, coupled with weaker financial firepower. In addition, their remote locations mean they must fish in local talent pools, which often have low stocks of skills such as software engineering and finance.
The structural realities facing midsize companies can make transformation harder, but they also have some advantages over their larger, better-resourced peers. For example, their tighter decision-making structures mean they can be more agile, helping them implement change faster and keep a tighter grip on transformation goals. And their smaller footprints allow for more targeted and rapid resource allocation, enabling experimentation without the massive coordination challenges facing larger companies. Meanwhile, the proximity of decision-makers to day-to-day operations offers swifter feedback loops and closer alignment with competitive dynamics and industry trends. The task for leaders in this context is not just to make the best of the situation but to harness the headwinds that can turn bold ambitions into reality.
Seven steps to peak performance
Our experience working with dozens of midsize industrial companies globally suggests that the most effective value creation pathways are founded on a strategic approach to managing the change process, alongside a focus on innovation and growth, in addition to rationalization or efficiencies. In practice, this means adopting a holistic mindset that aims to both mobilize people and maximize operational capabilities. Here, we gather seven levers that leading companies have shown can create lasting impacts on performance:
1. Go beyond firefighting to define your North Star
Given a common history of M&A-driven expansion, many midsize companies have neglected vital strategic and go-to-market planning for the longer term. Why does this matter? Without a clear direction of travel, or North Star, they tend to focus on tactical measures and daily operational decisions but do not allocate sufficient resources to delivering on their long-term vision. As a result, they often lack clarity on where to invest talent, capabilities, and time—and fail to mobilize resources accordingly. Leading companies, on the other hand, think carefully about their market positioning and the bold bets they want to make, which they continue to resource in tough times—reflecting a through-cycle mindset. Rather than focusing on opportunistic deals and sequential bottom-up initiatives, they define their strategic direction and track the leading indicators, market dynamics, and verticals that are most likely to drive revenue growth and margin gain—and ensure they regularly revisit their progress toward their North Star.
2. Get your operating model right: The whole can be more than the sum of its parts
With a firm grip on strategy, leading companies ask themselves whether they are set up to deliver on their aspirations. But often their operating model—the “connective tissue” and how different individuals interact and make decisions—is not aligned with their vision (see sidebar “Case study: Shifting the operating model to unlock new verticals”). For example, their marketing, product, and engineering departments might operate in silos, leading to ineffective commercialization of new products, particularly if they want to expand to other verticals. They may face significant challenges delivering on their customer promises because they do not have a global end-to-end owner making decisions on inventory management strategy. It is thus vital to take a hard look at potential changes to operating model design—namely, the structures, processes, and people shifts that will propel the company toward its North Star—and to make those changes quickly (Exhibit 2).
3. Do not cut costs into oblivion; maintain a focus on top-line growth
Larger companies have more bandwidth than their midsize peers to create value from efficiencies and cost reductions. One reason is that midsize entities generally do not have the same operating leverage: Some costs are fixed regardless of size. Thus, instead of simply prioritizing efficiencies, successful midsize transformations aim to drive revenue growth across the portfolio—for example, through entering adjacent verticals, cross-selling, upselling, and investing in aftermarket engines. They instill a growth mindset, align their operational rhythms to deliver on their strategic bold bets, and relentlessly drive commercial excellence (see sidebar “Case study: Driving revenues as a route to growth”).
4. Flip the script on pricing
Midsize industrials often retain SKUs because a particular customer needs them or because product management teams do not have the resources to closely manage the portfolio (see sidebar “Case study: Pricing for value”). The result is heavy product catalogs comprising tens of thousands of SKUs, often with overlapping characteristics and applications. In addition, companies persist with reactive and suboptimal pricing strategies, often maintaining stagnant list prices for years despite rising costs. Leading players tackle these challenges by adopting a strategic lens, optimizing prices to reflect individual product characteristics, full life cycle costs, and the value to customers. For custom products, they embed engineering and design hours into pricing structures, setting solid margin guardrails for individual projects. Many also revisit their product catalogs and identify specific disposition mechanisms for long-tail SKUs (for example, retire and replace or reflect the cost of maintaining SKUs in the price).
5. Do not underestimate low-hanging fruit on sourcing
Midsize industrials often say 50 to 80 percent of their cost base is external to their operations,1 but visibility challenges mean they fail to properly manage that spend. Instead, procurement teams focus on firefighting, an approach that leaves little room for strategic thinking and exposes companies to the superior tactics of larger, more sophisticated competitors. A worthwhile investment is to establish a strategic sourcing team and build a central source of truth for external spend (see sidebar “Case study: Rapid value creation in sourcing”). This approach will enable the business to consolidate spending across all business units, track key commodities, pay the same low price across business units, and create negotiating leverage. The time to impact can be accelerated through affordable digital tools (including spend cubes with built-in intelligence, eRFX [electronic request for x], e-auctions, should-cost models, automated contract analysis and management, and negotiation simulation for capability building). These tools can help teams understand the opportunities at stake, improve procurement processes by enabling communication and efficiency across operations, and reduce manual uploads in the procurement unit.
6. Be scrappy with your IT
Midsize companies pursuing full enterprise resource planning or IT system consolidation typically face implementation costs of about 2 to 5 percent of annual revenues—and on a relatively long ROI timeline of three to five years.2 On the other hand, a fragmented digital architecture creates real pain points (see sidebar “Case study: Leveraging data and AI to boost sales”). Leading midsize industrials find point solutions to drive impact and improve performance without necessarily waiting for a complete ERP transformation, which may take years. That could mean building applications on top of existing infrastructure (for example, creating data lakes and reporting layers to support multiple ERP systems), deploying basic automation such as robotic process automation for internal reporting, or selectively deploying gen AI use cases where they will make a meaningful contribution to the bottom line, such as with a gen-AI-powered sales agent.
7. Find your superstars
People are even more important to midsize companies than to larger organizations—mainly because of the outsized impact individuals can have on outcomes. But midsize industrials often fail to make the most of their human resources. Not surprisingly, a common challenge is high levels of turnover. Within leadership teams, these shortfalls can undermine decision-making and prevent strategic alignment.
Leading companies tackle talent challenges through programs designed to proactively identify and develop high-potential employees, often as a part of the transformation. Common strategies include the use of sponsorship and rotation programs, a clear plan for growth and capability building, and a commitment to providing rewarding career paths.
Midsize companies are the sophomores of the business world—full of potential but sometimes failing to see what transformation may lead to (if managed properly). The key to greater clarity on the transformation process is to adopt a strategic lens, a pragmatic mindset, and a steely focus on building scale. Our experience across numerous client engagements suggests this holistic approach can help companies transform more effectively and create a solid basis on which to build competitive advantage.
