One of my pet peeves at board meetings is the excuse that a company's lousy performance is acceptable because it's doing better than its competitors. Managers who are losing money or behind plan will frequently show up at board meetings with charts and graphs showing better inventory turns, more loyal customers or superior products or services than a selected list of competitors. But doing better won't necessarily pay the rent. To earn the right to use the shareholders' capital, managers must meet absolute standards, not relative standards.

This flies in the face of accepted practice. After all, managers say, we are all competing against someone for our customers' business. That's why managers track market share data and study best practices to improve their performance. But too narrow a focus on a company's existing competitors can breed complacency that will allow the next competitor to drive all of you out of business.

Wal-Mar, Nucor, Southwest Airlines and Home Depot are all examples of companies that were able to prosper by satisfying a customer need that was being ignored by existing competitors who were focused on beating each other. It is the competitor you can't see that will kill you.

The best way I know to avoid being blindsided by a new competitor is to focus entirely on the absolute level of quality you deliver to your customer. This is the principle that John Wooden, legendary UCLA basketball coach, used to teach his players. You don't make plans or run practices against specific opponents; you plan and practice to be your best. Period. You can't do this without absolute standards of performance.

I ran into an interesting example of this a few weeks ago in a company that had just completed a difficult combination of two businesses. When a company is going through a transition like this and managers expect there to be unavoidable problems, my goal is to throw enough extra resources at the problem to keep it from hurting a customer. That means bringing in extra temporary help, weekend training sessions and doing whatever it takes to protect the customer.

In this particular case the company wasn't able to do that. During the conversation from one computer system to another, the customer service reps temporarily lost the abilityto see into the plants to know if they had a particular product on the shelf to ship that day. Some customers' orders were delayed as a result. Others failed to get confirmation that their orders had been received.

The managers fixed the problems by establishing absolute standards for customer service. Their new policy: No order will be taken that cannot be shipped when the customer wants it. Every phone call will be answered on the second ring. Every order taken will be entered in the computer system with a confirmation sent back to the customer before anyone goes home for the night. Period. They executed this by bringing in extra people, and by putting the managers on the phones taking orders until the problems were solved.

Fortunately, this company had an extremely strong reputation with its customers--they didn't jump ship while the problems were being addressed. Most companies don't get the luxury of a second chance.

Absolute standards apply to a company's responsibilities to its shareholders, too. Being more profitable than other firms in the same industry is not good enough. Managers must generate risk-adjusted returns on capital that are systematically better than investors can earn on all other investments if they want to continue to use the owners' capital.

For most midsize companies that means generating aftertax free cash flow--cash profits adjusted for any necessary capital spending or increases in working capital--of at least 15% to 20% of invested capital per year, averaged over a three-to-five-year period. If the managers meet this standard, the board's job is to give them more capital to grow the business. If they don't, the board should get new managers or redeploy capital to other value-producing uses--or return the money to the owners through dividends or share repurchases.

Doing better than the other guy may be good enough for horseshoes, but in business it's absolute standards that really count.