Value Investing

Marathon Asset Management – Culture Vulture

Marathon Asset Management commentary for the month of February 2016, titled, “Culture Vulture.” This is discussed in their new book Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15 we think – anyway read it below.

Marathon Asset Management’s focus on management forces us to think about corporate culture

Corporate culture is constituted by a set of shared assumptions and values that guide the actions of employees, and encourage workers to act collectively towards a specific goal. Cultures both reflect the values, and are a prime responsibility, of management. Yet strong cultures can persist long after the careers of those who put them in place. Still, sceptics might ask, why should investors bother with something so ineffable, so intangible? Well, the evidence suggests that culture pays.

Marathon Asset Management: Corporate Culture and Performance

Perhaps the best known study of the subject is Corporate Culture and Performance by John Kotter and James Heskett. This work examines the relationship between corporate culture and company performance in over 200 firms during the 1980s. The authors asked employees their opinions of attitudes to customers and shareholders at competitor firms. Shares in companies exhibiting strong and positive cultures outperformed rivals by more than 800 per cent during the study period. Other studies which measure corporate culture according to how employees regard their own workplace have found a similar link between culture with market returns.

Kotter and Heskett’s work established that strong cultures are liable to produce extreme outcomes, both exceptionally good and dreadfully bad. Positive cultures can take different forms. Perhaps the most commonly successful corporate trait is an emphasis is on cost control. Almost every firm periodically engages in bouts of cost-cutting. Exceptional firms, however, are involved in a permanent revolution against unnecessary expenses. In the early days of Admiral, the British insurance company, employees wishing to use the printer were required to do a push-up in sight of the CEO. Another example of the corporate Scrooge is Fastenal, a US distributor of low value industrial products, which boasted the “cheapest CEO in America.” There are legends of Fastenal executives being required to share hotel rooms at conferences. Company offices are said to be decorated with second-hand furniture. Frugal cultures may not sound attractive to employees, but when married to decentralised profitsharing schemes they can work wonders. Between 1987 and 2012, Fastenal provided a return of over 38,000 per cent (excluding dividends,) better than any other company in the index. Take that, Bill Gates.

Cost-cutting is not the only successful cultural model. In fact, some firms have strengthened their cultures by spending more not less. The classic example is Costco, the discount retailer. Bucking the conventional retail model, Costco pays its staff more than the legal minimum wage – and far more than rivals. The average Costco employee makes in excess of $20 an hour, compared to average US national retail pay of less than $12 an hour. The company also sponsors healthcare for nearly 90 per cent of workers. Wall Street is constantly pressuring Costco to cut its wage bill, with the cacophony reaching a peak during the crisis of 2009. Instead, the company raised wages over the following three years. The return for this munificence is that Costco employees stay on longer, thus saving on training costs. Turnover for employees who have been with the company for more than one year is a paltry 5 per cent. Loyal employees are more likely to excel. Costco is regularly rated as excellent for customer service.

The point is that a strong corporate culture constitutes an intangible asset, potentially as valuable as a high profile brand or network of customer relationships. As Warren Buffett says of Berkshire Hathaway’s family of businesses: “If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength… On a daily basis, the effects are imperceptible; cumulatively, though, their consequences are enormous. When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as ‘widening the moat.’ ”

Marathon Asset Management – Story of a rotten culture: AIG

On the other hand, a rotten culture can be a firm’s undoing. Look no further than AIG, one of the major disasters in the recent financial meltdown. Dominated for so long by an imperial CEO, Hank Greenberg, the global insurance developed in the words of one commentator “a culture of complicity.” Unthinking obedience, the lack of an “outside view,” and an obsession with growth at any cost led to riskier and riskier positioning. Even as the end grew nearer, AIG executives proved incapable of recognizing the danger the company faced. In August 2007, the head of AIG Financial Products commented on his division’s positions in the credit derivatives market: “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of these transactions.” Little more than a year later AIG announced a quarterly loss of $11bn, which largely derived from its Financial Products division.

Just as positive cultures take a number of different forms, so too can negative ones. An obsession with growing earnings occasionally results in outright fraud. In the 1990s, during the tenure of Al ‘Chainsaw’ Dunlap, the accounts of consumer appliance maker Sunbeam were concocted to meet aggressive earnings targets. In extreme cases, a poor corporate culture can have tragic consequences. In 2010, 29 miners were killed in an explosion at one of Massey Energy’s coal mines. The US Labor Department investigation blamed a corporate culture that “valued production over safety” and fostered “fear and intimidation.”

If a beneficial culture is a valuable intangible asset, and a corrosive one an existential threat, it becomes important to ask: how can an outside investor tell the difference? As with so much of investment, the process is one of piecing together incomplete and obscure pieces of evidence, gathered over time through meetings and research.

Some quantitative measures can be helpful: staff loyalty and inside share ownership are liable to be higher at firms in which employees believe in what they are doing. Corporate incentive schemes say a lot about the firm’s culture. Is management being greedy? What performance metrics are valued – growth for its own sake or customer satisfaction? What do employees think? Opinions can be unearthed through websites such as glassdoor.com (a sort of TripAdvisor for companies). We are constantly looking out for signs of management extravagance and vanity. Danger signs include expensive executive travel (a corporate jet is liable to elicit groans), too numerous pictures of the CEO in the annual report, and dandyish attire.

There are numerous examples of successful cultures among our portfolio companies. The empowerment of branch managers that promotes responsible banking at Sweden’s Svenska Handelsbanken, for instance. Reckitt Benckiser, another holding, fosters an entrepreneurial spirit among its senior managers. Yet even if a strong culture is instilled in a company, it can take many years for its full effects to play out. That may be beyond Wall Street’s limited investment horizon. Long-term investors, however, would be wise to take heed.

Check out more at Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15

Marathon Asset Management - Culture Vulture
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