What is ‘Culture‘ and how does it affect the operational success of an organisation?
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Without doubt, if there is one aspect of an organisation that will separate the great businesses from the mediocre or the poor, it has to be the company's Culture. Businesses with healthy Cultures tend to be successful and provide attractive investment opportunities whilst those with cultures that are sick or decidedly unhealthy tend to perform poorly, leading to share price under-performance or even worse, the permanent loss of capital. It is for this reason, the Investment Masters recognise the importance of Culture in the investment decision-making process.
“Culture is king” Sam Zell
"The real glue of investing is understanding what the Cultures are in the businesses" Thomas Russo
A company's intrinsic value is determined by it's future earnings, and while past financial statements may provide clues to the quality of the business, changing conditions can make extrapolation of past results unreliable. In a large part, a company's future success will be a function of the culture. And culture is difficult to measure given its qualitative rather than quantitative nature. It is for this reason that culture often gets overlooked in the investment process.
Marianne Jennings, in her book, 'The Seven Signs of Ethical Collapse' [nb. recommended reading by Jim Chanos, the world's most famous short-seller] noted that "A good analysis of where a company is headed demands a look at the qualitative factors , those touchy-feely, squishy, from-the-gut factors that are ignored despite the fact that they often determine the company's fate".
James Heskett, a leading authority on corporate culture, noted that culture can be a better indicator of a company's future financial performance than hard numbers... "The decline of an organization's culture may well precede financial decline".
Great companies have great cultures. Ed Catmull, co-founder of Pixar, discussed culture in the first paragraph of his great book 'Creativity Inc' [new blogpost on this book coming soon!]. The book's introductory paragraph highlighted that what made Pixar was 'the unique culture that defines this place'.
So why is it so important?
A company could have the greatest products, a robust brand and reputation, effective policies and processes and a long history of trading, but if the culture is poor, it is much less likely to succeed when compared with a business that has a healthy culture.
Despite those great products, you might find that many customers have complained about slow delivery, or poor service, or rude employees in that business. These are all indicators of the health of a company's culture.
Companies with great service and employees that go the extra mile rarely have complaints made against them. And if they are not making complaints, then customers will return to the better businesses, leading of course to better business results. Its that simple.
"As much as half the difference in operating profit between organisations can be attributed to effective cultures" James Heskett
“A rotten culture can be a firm’s undoing” Marathon Asset Management
"Long term, culture is enormous in terms of one business doing better than another," Paul Black
“Perhaps the best known study on 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 1980’s. 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% during the study period” Marathon Asset Management
A successful culture is a competitive advantage that can be difficult to compete with and challenging to replicate.
"In many organisations, culture is the most potent and hard-to-replicate source of competitive advantage - far more important, for example than technological innovation" James Heskett
“A strong corporate culture constitutes an intangible asset, potentially as valuable as a high profile brand or network of customer relationships” Marathon Asset Management
"Organisations with strong, adaptive and open cultures that foster employee loyalty and productivity are not concerned that competitors may find it possible to borrow policies, methods and processes. They are convinced that the real key to making those policies, methods and processes, and yes, strategies work is something much more difficult to emulate - culture," James Heskett
How do you describe what an organisation's Culture is?
Look at it this way: if we are asked to 'describe' a person, the answer lies in their personality and behaviours sets. They could be confident, assertive, organised, decisive, and pragmatic as an example.
If you then consider the Culture of an organisation to be much the same thing, when we describe it, we will be outlining how we see the business' 'personality'. By the same standard, it could be defined as competitive, aggressive, customer-focused, mature, cost-conscious and well-respected. On the other hand, a company with a poor culture could be described as lacking in Leadership or Integrity, and with a non-customer centric focus.
How is a company's Culture created?
In a nutshell, there are two things that determine a company's Culture. These are either 1/. a Company's Vision and Values, and/or 2/. the Behaviours of the Management/Leadership Team.
Company Values have long been touted by some companies as HR rubbish, or soft and fluffy BS that wastes everyone's time. The reality is actually something else entirely. If a company goes to the effort of creating a set of Values, it is essentially defining the organisation's Code of Conduct.
So taking this one step further, if the company's Vision and Purpose determines What it wants to be in the future, and the Strategies outline How it will get there, think of the Values as the Manner in which it will behave along the way. Values could also be seen as the company's behaviour set.
In the case of Vision, Amazon's vision is “to be Earth’s most customer-centric company, where customers can find and discover anything they might want to buy online.” or Southwest Airlines vision to be the "Airline for the Common Man". Google has a purpose "to organise and make accessible all the world's information". Successful companies have a purpose and vision other than 'making money'. In all cases, these Visions will contribute to each of these company's behaviour sets.
Values will also differ from business to business. When setting their Code of Conduct, many use words like Integrity,