GreenWood Investors: Sustainability & A Kick A$$ Culture

This article is the second of a 6-part series examining how the drivers of value creation are the same as sustainability drivers. We outline these drivers in 6 posts to show how recent ESG efforts to define business sustainability fall very short.

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Q3 2020 hedge fund letters, conferences and more


In our first in the 6-part series on the multi-faceted aspects of a company’s sustainability, we discussed how the customer relationship is among the most, if not the most, important relationship that drives the long-term sustainability of a business. But there are some notable Builders that would take an issue with that view.

Michael Zimmerman’s Prentice Capital is having a strong year

business manPrentice Capital was up 15.3% net last month, bringing its year-to-date gain to 49.4% net. Prentice touted its ability to preserve capital during market downturns like the first quarter of this year and the fourth quarter of 2018. Q3 2020 hedge fund letters, conferences and more Background of Prentice Capital The fund utilizes a low Read More


Danny Meyer, of Union Square Hospitality Group and Shake Shack, argued that the first key stakeholder, particularly in his hospitality business, are the employees. In his terrific book, Setting the Table, Meyer asserted that if the team isn’t working well together, and his people are not in a career that fits with their skills and personality, then he could not have happy customers. In his restaurants, the bar-tenders, wait staff and hosts are the primary determinants of the customer experience. If the restaurant’s team wasn’t functioning to the highest standards Meyer set out for his group restaurants, then the customer experience didn’t reflect Meyer’s aspirations of “Enlightened Hospitality.”

To build an organization that exhibits Enlightened Hospitality, Meyer applies what he calls “constant gentle pressure.” In his own words, “Fire is the most important element in management’s application of constant gentle pressure. During my early inexperienced years as a boss when I first got into business, it was far more important for me to please people and be liked than to be respected. By abandoning my fire, our excellence suffered. The biggest mistake managers can make is neglecting to set high standards and hold others accountable. This denies employees the chance to learn and excel. Employees don’t want to be told, ‘let me make your life easier by enabling you not to learn and not to achieve anything new.’”

So while the term “enlightened” would conjure images of sitting by Walden Pond or a buddhist monk meditating, Meyer actually defined enlightened hospitality as the opposite, one of “fire.” So contrary to many Silicon Valley firms emphasizing how many masseuses they have, or how many kegs get consumed by employees over a ping pong table, an enlightened team is not one that’s focused on the frills, but one focused on the fire. It’s an intensity to be the best they can possibly be.

A Culture That Serves the Customer

Sir Martin Sorrell, who I wrote about in the first article, has that fire. His company S4 Capital is acquiring companies at a torrid pace, and many of these deals are happening through reverse inquiry. He has created an environment which founders want to be a part of. His acquisition model requires them to roll half their take-out value into the stock of the company, with multi-year lock-ups on their shares. It’s a confederacy of founders, all challenging each other to be better, of course under the umbrella of one of the most public workaholics in London, if not the world.

An engaged culture is one where employees are realizing their full potential, and are aligned with the same mission. In S4’s case, these founders and managers quite often talk about creating the future of advertising. While as advertising guys, they’re remarkably great at framing a story, in their most recent investor day, their key partners in Google, Amazon, as well as the founders of the companies they’ve acquired, laid out a compelling case why S4 was very different from the legacy industry, much of which was built by Sir Martin himself.

S4’s motto of “Faster, Better, Cheaper,” is a no-brainer customer proposition for the giant Rolodex of the founder. But the real secret of S4’s recent success is the team-oriented structure as opposed to the siloed competitive atomsphere he helped create at the advertising holding companies. There, very talented teams would compete against other areas of the firm to win clients, and were only compensated on their silo as opposed to the firm. This impaired the team’s ability to cross collaborate. S4’s model is quite different. Founders and managers are incentivized on the overall share price of the company by requiring them to maintain hefty skin in the game. Relationships, technologies and skill-sets are cross-applied throughout the organization to produce organic company growth consistently >20% higher than the industry.

As Danny Meyer and Sir Martin have shown, the right culture is a pre-requisite towards serving the primary stakeholder in any business relationship: the customer. Even Sam Walton, who we discussed in the first article, myopically focused on customer satisfaction, eventually realized the key to serving the customer well was having a workforce that was able to delight that customer through every interaction.

As Sam wrote in Made in America,

“As much as we love to talk about all the elements that have gone into Wal-Mart’s success — merchandising, distribution, technology, market saturation, real estate strategy — the truth is that none of that is the real secret to our unbelievable prosperity. What has carried this company so far so fast is the relationship that we, the managers, have been able to enjoy with our associates…

Now, I would love to tell you that this partnership was all part of my master plan from the beginning, that as a young man I had some sort of vision of a great retailing company in which all the employees would be awarded a stake in the business. That I saw them having the opportunity to participate in many of the decisions that would determine the profitability of that businesss. I would love to tell you that from the very beginning we always paid our employees better than anyone else paid theirs, and treated them as equals. I would love to tell you that, but unfortunately none of it would be true…

The larger truth that I failed to see turned out to be another of those paradoxes — like the discounters’ principle of the less you charge, the more you’ll earn. And here it is: the more you share profits with your associates— whether it’s in salaries or incentives or bonuses or stock discounts— the more profit will accrue to the company. Why? Because the way management treats the associates is exactly how the associates will then treat the customers. And if the associates treat the customers well, then the customers will return again and again, and that is where the real profit in this business lies, not in trying to draw strangers into your stores for one-time purchases based on splashy sales or expensive advertising.”

I’m sure even Sir Martin, a true ad man, would take no issue with that last statement. But while Walton was slow to realize the importance of creating a healthy culture to serve the customer, he certainly caught up very quickly. He established profit sharing plans, which made many regular employees of Wal-Mart very wealthy over time.

In accepting the Presidential Medal of Freedom, only a month before he passed away, Walton gave no long-winded ceremonious speech other than to thank the Wal-Mart associates who enabled the company’s unprecedented rise. “The greatest thing is that we’ve got ideas from all 380,000 people at the company. That’s the best part, we’re all working together. And I hope we can keep it going that way, that’s the secret, that’s the key. And if we can, we’ll lower the cost of living for everyone.” This was a man who had truly believed in creating a kick-ass company culture to the point it was the only thing he could mention when the President gave him the highest award for a civilian in the United States.

But as the post-Sam experience of Wal-Mart has shown, a good employee-manager culture must be earned every day through actions, not through past deeds or words. After Walton passed, the culture which was once focused on the employee, got diluted. Over time, the profit-maximization got so bad that Walmart actually set up a department to help advise its own employees how to obtain Food Stamps and other government aid programs due to the low wages. Quarterly earnings and the executive options took precedence over employee welfare, and everyone suffered as a result, including shareholders. Since the cultural nadir a few years ago, Walmart’s current executives have gone a long way towards restoring the original associate relationship that Walton prided himself and the company’s success upon. And we’ve seen the company respond resiliently throughout Covid-19, actually beating Amazon and Whole Foods to becoming the number one online grocery retailer in the United States.

Amazon And Whole Foods: A Conspiracy-Driven Culture

But John Mackey at Amazon's Whole Foods continues to build his firm, now having been freed from not having to focus on excessive demands of the short-term Wall Street voices. Mackey knows sustainability. His Whole Foods Market has been a pioneer in getting food suppliers to adopt more sustainable methods, focusing on ecosystem and animal welfare.

He founded the Conscious Capitalism movement to help restore Capitalism to its original roots of putting the customer and employees before short-term oriented shareholders. In a follow-up to Conscious Capitalism, John recently penned Conscious Leadership with co-authors Carter Phipps and Steve McIntosh. Mackey and his co-authors share the behaviors and management style that Mackey adopted in order to ensure the Whole Foods culture met his lofty ambitions.

What may surprise some, but probably not you at this point, despite the focus on having an enlightened culture, Mackey’s management style isn’t all kumbaya. Mackey is a modern Adam Smith, who also initially identified himself as a moral philosopher. Mackey echoes the sentiment expressed on Walmart above in the need to re-earn the culture every day. “It is important for a leader to remember that when it comes to creating culture, it’s not about what you say you believe in; it’s about what you actually do— what you model as a leader, and most important, what you incentivize in the culture every day.”

Mackey has imbued Whole Foods with a culture of healthy competition. He emphasizes distributed decision-making and freedom to enable an idea meritocracy across the organization. “A healthy competitive dynamic is born, with each team trying to outperform the others and come up with more innovative ideas. The best ones get replicated across the company, and the ones that don’t work fade away… That distributed autonomy inspires the creative spirit of our teams in a manner that never would happen if our corporate headquarters dictated the exact design of every new store… Competition.. is not antithetical to collaboration.”

The graveyard of corporate failures is loaded with tombstones of centralized, command and control organizations. It’s interesting to see Mackey express much freedom of management in the wake of its acquisition by e-commerce behemoth Amazon. Rather than diluting Whole Foods' culture, Mackey talks about how much he’s learned from Amazon executives to strengthen and scale the Whole Foods culture.

But perhaps the most important leadership point that Mackey touches on in his recent book is the importance of having a purpose or mission, which he strengthened and called a “conspiracy.” “There is a sense that all team members are in on a secret, and opportunity that the rest of the world doesn’t yet appreciate or see.” That certainly sounds like our investing style, and it motivates us to push further to discover things we feel others are missing, which will give us an investment advantage if we are right. In the same sense, the conspiracy helps give that organization an operational advantage over their competitors.

“You can’t start a conspiracy if people don’t feel in on it. They need to understand more than how; they need to know why. They need to understand the overall goals of the business and how they fit in. They work more effectively if they have a stake in the enterprise, and while some of that is financial, it’s also social. In the book Play Bigger, the authors echo this point when they point out that the most successful companies tend to be ‘category kings.’ They define a new market category and have some sort of strong ‘point of view’ on exactly how they are altering the market space for the better. Whole Foods has a point of view about healthy eating; it’s built into every store we create. Salesforce has a strong point of view about software. Airbnb has a strong point of view about travel and hospitality. In other words, conspiracies have a story that creates a shared emotional worldview, an internal set of touchpoints that bind a group together and inspire their work.”

Purpose and missions are over-used concepts in corporate and consultant pitch books that they have largely lost their original meaning. We like Mackey’s and his coauthors’ points about creating a conspiracy culture. It’s far deeper and emotionally engaging than a “mission.” And as we’ll see later, the human brain needs a constant emotional connection to what we do in order for it to be rewarding and engage the most effective parts of our brains.

The Truth Lies in the Data

Danny Meyer noted how his dad, who had a travel company when he was younger, would always emphasize the importance of having a great manager that he could trust to run his various investments. Global investors have been very correct to emphasize the importance of having a a great management team to guide their companies. The difference between a great and a good manager typically translates to a very significant difference in underlying stock performance. This is particularly crucial in capital intensive industries, where the returns managers produce largely depend on their ability to generate impressive returns on those capital investments. Will Thorndike wrote extensively about this in his terrific work The Outsiders.

But perhaps even more important than a managers’ ability to allocate capital is the managers’ ability to inspire a conspiracy-led culture. A good CEO is very important to the capital allocation process, but the businesses’ operational and commercial presence is rarely determined by the CEO or the management team. Rather, it’s the environment the CEO sets that creates the preconditions for customer happiness and engaged employees, two of the most fundamental aspects of both sustainability, and, as it turns out again, investor performance.

Thanks to my colleague Kveta compiling employee ratings from Glassdoor, we were able to study the correlation between employee engagement to stock price and company performance. We were surprised the correlations were actually slightly stronger than the correlations to customer satisfaction. This could just be because we used a very standardized and uniform source for information, so the data reliability was cleaner. But maybe Danny Meyer was right. Employee’s recommending the company to a friend has correlated to stock price performance by 21.0% since 2014. The employee rating of the CEO was actually the strongest, with a 28.6% correlation to stock price performance. By quintiles, the share price performance is as follows.

Exhibit 1: S&P 500 Share Price CAGR According to CEO Rating, Recommendations to Friends

CEO Approval

Friend

Data Source: Glassdoor. Download our data compilation here.

While Kveta was grabbing Glassdoor data, we also analyzed if the difficulty of the interview would have a correlation to stock price performance. Our thesis was that firms that had very difficult interviews would suggest it was a great place to work, and where only the best candidates get jobs. That indeed was correct, but by a slightly lower correlation, 17.3% over the past ~6 years. But the stronger signal was CEO ratings and whether or not the employee would recommend the firm to a friend.

More engaged employees also do generate better customer satisfaction, just as Meyer asserted. But the correlation is not strong enough to suggest that the only thing we need to worry about is employees and the customer satisfaction will take care of itself.

Exhibit 2: Employee Engagement & Customer NPS

Amazon Whole Foods

Data Source: Glassdoor, Customer Guru, Company Reports

Job Security vs Job Effectiveness

Writing this article from heavily unionized Europe, one would wonder what role unions play. The monopolization of the industrial economy in the early 20th century often saw the trade off of value distribution skewed heavily towards the shareholder, a topic we’ll cover in the next sustainability article.

Buckling under aggressive work conditions that sought to squeeze labor’s share of the profits, unions served an effective means of restoring balance. Balancing dichotomies, as articulated by John Elkann and the late Sergio Marchionne, is key to resilient value creation.

But in modern times, unions have maintained very little meaning or reason for being, and perhaps are self destructive. Since we mentioned Sergio Marchionne, let’s take the auto industry, one in which we’re very well acquainted with. The more the unions have demanded pay rises and job security, the more these companies have robotized the production process. Touring one of FCA’s auto facilities today consists of winding your way through humming machines, and occasionally encountering an assembly employee, largely making sure the machines have a helping hand. The jobs are not being lost to lower cost countries, they’re largely being lost to automation.

Sergio Marchionne’s management style was a perfect illustration of being both kick ass and empathetic. One would have thought managing three major international businesses (FCA, CNH Industrial, and Ferrari) would have left him distracted and transactional. He was the opposite. He was focused, and he met individually with thousands of managers a year to ensure they were motivated, goal-oriented, and right for their job. He wanted his team to grow. Actually he demanded it. Executives would joke that they’d all wind up divorced after working for Sergio for a year or two. He demanded their best, and he consistently got it. Perhaps the executive which he worked hardest, FCA CFO Richard Palmer, lost his composure publicly the day of the earnings call in which the executives had just learned of “SM’s” passing. Conventional wisdom would think Palmer would have been relieved to have a less demanding boss. His tears confirm the opposite.

The root of the union problem isn’t a value trade off between two opposite parties, as this dichotomy is often perceived. To us, the problem is more an issue of effectiveness. Capitalism is a fast-moving, innovative, competitive force that yields unabated progress. This often means what is right for a company at a certain stage is not the same answer at a later stage.

In Conscious Leadership, John Mackey explains how his father served as his mentor during the first 16 years of Whole Foods’ development. One can hardly think of a more meaningful relationship than that of a father and the son. Yet, at a more advanced state of its progress, Whole Foods needed a different bench of advisors than John’s father. He notes how the ending of that advisory relationship was painful, but necessary. Mackey also talks about having received thank you notes from former employees who he had to let go of, when the relationship no longer served both parties equally. It’s not about job retention. It’s about job effectiveness.

In a similar experience, Danny Meyer started famed Union Square Cafe with his initial chef, Ali Barker. As Union Square continued to develop, Meyer needed a slightly more experienced & aspirational chef, one who was aligned with growing the restaurant group into more than just the neighborhood cafe. That also led to a natural parting of ways. Many tears were shed, but both men believed the move was the right one as their paths parted ways.

In our opinion, the biggest problem with the traditional union mindset is not that union leaders ask for pay increases, it’s that they demand to keep people in roles that are no longer as relevant, or roles where they can no longer embody their best and highest use. They remove effectiveness from the equation, and untether rewards from merit. That is soul sucking to an organization, particularly one with very capable team members watching others receive the same benefits and pay with sometimes a cavalier disregard for their effectiveness.

One thing I’m trying to help articulate at CTT, which is also heavily unionized, is that we need to continue to pull people from traditional mail routes to staff up our parcel routes, which are not always merged, particularly as parcels growth accelerates. Our revenue growth has been picking up pace and will continue to accelerate, as e-commerce begins its penetration in a society which is only ordering roughly 1/10th online as neighboring Spain does today. Our manpower needs to grow with this, but we must shift people from legacy declining areas to parcel routes. We are fortunate to have a growing need for people, as the opposite is a far more difficult problem, but we still need some flexibility on function and we need to continuously meet customer expectations. That means, just like Danny Meyer expressed in Setting the Table, employees need to be focused on surprising and delighting the customer. That means we all need to evolve together, and perhaps some may be better off in a different role.

As even the most conscious leaders have shown, it’s not morally right to insist on staying in an occupation that doesn’t allow us to utilize our strengths and self actualize. And it’s not just unionized Europe that has this problem, but a disengaged work culture has long plagued the United States.

The Guiders

So many companies today are being run to hit quarterly profit guidance. Inadvertently, managers who have boxed themselves into this quarterly profit guidance have put themselves on an ever-accelerating treadmill. As the red queen expressed to Alice in Through the Looking Glass, “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

The Gallup polling organization, whose CEO Jim Clifton developed the Strengths Finder framework, has been surveying workplace engagement for a couple decades now. The surveys consistently have shown two thirds of American workforces are either disengaged at work or even actively disengaged. Clifton’s work has proven that organization that focuses employees on maximizing their strengths as opposed to working on their weaknesses generate consistently better performance.

But most firms are not fitting the strengths of their employees to their roles. Furthermore, while firms do have mission statements, as a “best practice,” the mission is consistently ignored at the expense of generating results to “beat the quarter.” They have no “conspiracy,” as John Mackey would say.

Exhibit 3: Gallup Workplace Engagement

Amazon Whole Foods

Source: Gallup Organization

When employees are consistently boiled down to monthly and quarterly KPI quotas (“key performance indicators”), all sense of mission and purpose is lost. It’s difficult to get excited about hitting a CRM target if you’re not constantly reminded why you’re there in the first place.

Thus, the “Guiders,” as we call them, or managers who gear their entire firm’s purpose towards beating the quarterly guidance (a notable extreme example would be Jack Welch at GE), are actually destroying the culture of their firms by focusing most regularly on KPI quotas and very seldom invoking the mission, or conspiracy.

Firms that reject the quota culture, and rather, focus on creating an engaged workplace perform considerably better than those stuck in their KPI spreadsheets.

Gallup recently refreshed its analysis of employee engagement in 276 organizations, across 112k business units and in nearly 100 countries to find continued strong relevance to employee engagement and company performance. Comparing the top quartile to the bottom quartile (the top 25% versus the bottom 25%), Gallup found that higher engagement of employees generated a 10% boost in customer loyalty, a 23% boost to profitability and an 18% boost to sales productivity. So the focus on employee engagement has real financial repercussions to shareholders, perhaps even more than the capital allocation skills of the top bench.

Return of the Right Brain

As profiled in his most excellent book The Master And His Emissary, Iain McGilchrist showed how the center for human-connection in our brains is decidedly in the right hemisphere. Neuroanatomist Jill Bolte Taylor also experienced this when a hemorrhage took out the entire left side of her brain.

As Jill experienced first hand, the left side of the brain rules language, and systematizes things, classifies and maintains order. It’s the world of the KPI, of the CRM (customer relationship manager) and the role of HCM (human capital management) systems. As the language center, it would also seem to be the driver of the TLA (three-letter acronym), which we all roll our eyes at. But the left brain is very effective at systematizing a goal or initiative. It’s role is to enhance productivity and it’s often very good at this in normal times. And as McGilchrist pointed out in his book, the world is becoming more and more obsessed with left-brain thinking.

This is also exemplified by a book we very much liked, Measure What Matters, which explains Google’s system of managing through OKRs (there it is, another TLA – this one means, “Objectives and Key Results.”). OKRs try to blend right brain missions and objectives to a measured system, so organizations can more easily track if they’re on course for achieving their goals and mission.

I readily adopted the OKR system at GreenWood, my left brain seizing another way for us to produce consistently demanding performance and results. I think my colleagues have been more reluctant to using it, and I think the reluctance comes down to the fact that many of the day-to-day important things cannot be readily translated into OKRs. But they still have great meaning and importance. The next novel investment insight cannot be imagineered on demand. As we know from Gary Klein’s work on how insights occur, there is no reliable system for producing them, they happen unexpectedly and most typically when the right brain is in control. OKRs, like checklists, short circuit the brain’s usage of the right hemisphere.

All of the TLAs discussed here are inherently left brain. As Iain McGilchrist pointed out in The Master And His Emissary, the left brain understanding of the world is very limited. Only our right brain can understand the full picture, respond to new and unexpected information, and derive meaning. When the right brain’s creative possibility gets translated into language, into a system, it inherently loses some of its meaning and mojo.

As Jill Bolte Taylor pointed out in her brief right-brain-only experience, our source for human connection, for joy and for meaning comes exclusively and undeniably from the right brain. That’s where love and joy are present. When our companies, jobs and economy increasingly become process-oriented and left brain, while they may be productive and effective, but that work has lost all the joy and meaning. It has also lost the creative possibility and comprehensive understanding of the whole. That’s what we think is wrong with many organizations today, and why a disengaged workforce is an outcome of a stagnant culture and company fixated on monthly operational performance.

Kicking Ass

As my friend Marianne Williamson wrote in her book The Law of Divine Compensation, “In summation, there are four rules for miraculous work creation: Be Positive. Send love. Have fun. Kick ass. Amen.” Marianne is an expert at getting people to manifest their best selves. A great company manager needs to be the same.

That doesn’t mean the message from the top is all gumdrops and lollipops. I’ve been with Marianne on innumerable occasions when an entrepreneur, artist, or aspiring creator asks for career advice. The advice is almost never “you’re awesome, just keep trying.” Good advice seeks to align effort and talent towards a goal that calls for those skills. It needs to be a good match between both the entrepreneur and the mission. It’s not just about hoping and praying. Success calls for a candid self assessment, and yes, a significant amount of hard work. That message is hard for managers to give lovingly, but Marianne is an expert at it. If the managers are parents, we suspect they already know the way to do this gently and empathetically, but it takes a lot of patience and energy.

There must be an exciting or engaging mission or conspiracy (being positive). There must fundamentally be a human connection aside from just monetary compensation (sending love). While every single career carries with it the burdens of bureaucracy, the daily tasks need to be more engaging, fun and right-brain stimulative than rudimentary left-brain routines to attract the best talent (having fun). And lastly, the team must be motivated to create completely new possibilities and reach far beyond their competitors (kicking ass). While it may sound trite, particularly to an economics and investing crowd, the human element of the business cannot be analyzed with a left-brain, systems-oriented mindset.

But as investors, we at least have tools to measure whether or not a culture is engaged. Quite simply, it’s not just the difference between a great culture and a basic one, it’s the difference between kick ass investor returns and merely average ones. That’s not just sustainability, it’s value creation.


To read the prior article (Part 1) of this series, Sustainability & The Ultimate Intangible, click here.


DISCLAIMER:

This article has been distributed for informational purposes only. Neither the information nor any opinions expressed constitute a recommendation to buy or sell the securities or assets mentioned, or to invest in any investment product or strategy related to such securities or assets. It is not intended to provide personal investment advice, and it does not take into account the specific investment objectives, financial situation or particular needs of any person or entity that may receive this article. Persons reading this article should seek professional financial advice regarding the appropriateness of investing in any securities or assets discussed in this article. The author’s opinions are subject to change without notice. Forecasts, estimates, and certain information contained herein are based upon proprietary research, and the information used in such process was obtained from publicly available sources. Information contained herein has been obtained from sources believed to be reliable, but such reliability is not guaranteed. Investment accounts managed by GreenWood Investors LLC and its affiliates may have a position in the securities or assets discussed in this article. GreenWood Investors LLC may re-evaluate its holdings in such positions and sell or cover certain positions without notice. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of GreenWood Investors LLC.

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