The secrets of the best small cap companies

Exhibit 1: Small-mid niche-focussed players have been the biggest wealth creators of the past decade driven by their superior earnings growth and return on capital

A few of the above names such as Eicher Motors and Page Industries have now become multi-billion dollar market cap companies as their niches have drawn in a large number of customers from the mass market, thanks to Royal Enfield’s and Jockey’s aspirational appeal to mass-market brand consumers.

Key pillars of successful niche MSMEs: Learning from Hermann Simon

We have found German management guru Hermann Simon’s ground-breaking book ‘Hidden-Champions of the 21^st Century’ (1996) particularly useful in identifying the traits associated with successful niche MSMEs. Simon’s book focuses on small companies with revenue below $4 billion that are market leaders (number 1, 2 or 3 in the global market or number 1 on their continent) and yet very few people know about them due to low level of public awareness.

He calls them hidden champions. Based on his extensive analysis of thousands of such champions across the globe, Simon has identified certain common characteristics which he believes has made them successful and helped sustain their success for decades. We find these traits to be particularly useful in helping us identify champion franchises for our Little Champs Portfolio.

Simon identifies the following key traits of hidden champions from his analysis of several companies over a long period - brief excerpts from the book are reproduced below:

• Growth and market leadership

• Hidden champions pursue ambitious goals, particularly with regard to growth and market leadership. These goals are formulated very early in the company’s life and communicated unequivocally across the organisation. Interestingly, the goals are long term in nature extending sometimes over generations rather than quarters.


• Growth is often achieved through successful innovations and expansion into new markets.


• Market leadership is driven not by aggressive pricing, but through superior performance, innovation, quality and reputation. 

• Market and focus

• Hidden champions typically define their market narrowly. For example, La Opala has deliberately focused on the niche Opalware crockery market rather than the much larger crockery market in India in general.


• Once they have selected a market, the hidden champions show a strong and lasting commitment to it.


• Focus on the core business enables these champions to track their market closely and defend their positions to evolving customer needs and technological developments. 

• Innovation

• Innovation applies not only to technology and products but more so to business processes.


• Furthermore, process innovations are not just restricted to cost reduction, but also applied with regard to quality, faster development cycles and thus, help in delivering higher value to customers.


• Top management generally plays a key role in driving innovation. This involvement is not only in the initial and early phases of a hidden champion’s life, but throughout the life cycle of the company. For example, in almost every single company highlighted in the first table of this note, the promoter continues to play a central role in driving innovation and R&D (research and development). 

• Customer orientation

• Hidden champions may be little known to the general public, but they are well known in their industry and enjoy a strong reputation among their customers.


• The customers’ demand is aimed at performance (quality, reliability and timely delivery) rather than low prices. The products and services supplied by hidden champions offer not only top quality but also increasingly comprehensive solutions which are hard for others to deliver -- and thus become significant barriers to entry.


• Top management values continuous direct customer contact and practises this on a regular basis. This is possible due to their manageable size, decentralised organisational structure and regular customer contact by top managers.

• Financing and organisational structure

• Hidden champions typically generate healthy profits and free cash flows and a high return on capital employed. To that effect, self-financing remains the most important source of financing for them creating a virtuous financial circle. You will note that very few of the companies mentioned in the table have relied on debt to finance their growth.


• Hidden champions typically exhibit decentralised customer-oriented organisational structure (empowered frontliners) with a very lean top management.


• These companies strongly outsource non-core competencies. This is less for cost reasons than to derive higher quality from specialised suppliers. 

• Work culture

• Hidden champions see employee loyalty, training, motivation, and flexibility as their key competitive strengths.


• The work culture of hidden champions is not subject to the political correctness of the time, but characterised by aspects such as long-term loyalty, intolerance of laziness and strict selection. For example, a significant barrier to entry set up by Page Industries is its labour force. While Page’s competitors struggle to retain workers for more than 9 months, a typical Page employee stays with the firm for 9 years. That in turn allows Page to generate labour productivity which are many multiples of what its competitors can generate.


• Multi-functional assignments and transfer between functions are more widespread at hidden champions than in large corporations. This flexibility results in better performance at lower costs.


• Hidden champions ensure they have more work than people. This condition minimises unproductive activity and proves to be an extremely effective productivity driver.

• Organisational leadership

• The leaders of hidden champions are fearless. As entrepreneurs, their personal fortunes are often inseparably tied to the success of their companies: If their companies fail, they stand to lose everything. Clearly, they possess courage and fearlessness to take risks.


• The leadership continuity of hidden champions is much stronger than that of large corporations, with leaders staying at the helm for 20 years or more. This is also why “single mindedness” is far more pronounced among the leaders of these champions.


• Hidden Champion leaders often spend their entire lives, or at least decades, with a single company. Thus, the plans and goals implemented by the leaders of are often shaped by extremely long-term strategic thinking. In this context, you might want to read our blog on leaders who play the “infinite game”.

The question is, would focus on a narrow market together with a high market share act as limiting factor for long-term growth? Hidden champions, as per Simon’s findings, have often overcome this challenge through the following routes:

1. Globalisation (can also apply to expansion into new states in the Indian context): Globalisation not only makes even the narrow markets large, it further contributes to growth in profits through economies of scale. The foundation for the success of this strategy is that customers in the same industry tend to have similar needs across countries.
   Hence, it is better to expand regionally in a narrowly defined market than to enter different markets in the same region. Hidden champions prefer their own subsidiaries for global business than entering a tie-up or alliance with a foreign partner. For example, Symphony has preferred to acquire air cooler manufacturers as far afield as the US and Australia rather than entering tie-ups.


2. Soft diversification: Particularly over the past two decades, diversification has been increasingly been employed by hidden champions to keep the flame of growth glowing. Besides the growth objective, better exploitation of existing competencies and know-how are another important motive for diversification. But wouldn’t diversification raise the risk that the hidden champion’s focus may be lost?
   To overcome this risk, these players employ ‘soft diversification’ where new units stay close to the traditional business, both in terms of technology and market. Furthermore, new business units are organised and managed like hidden champions.

Saurabh Mukherjea is founder and Ashvin Shetty is portfolio counsellor at Marcellus Investment Managers. Views are personal.