The culture of a business is paramount to its success, but what exactly is culture and why should we care to explore it? Venture Capitalist Ben Horowitz explains it well in his 2019 book ‘What You Do, Is Who You Are’ as he lays out the intricacies of culture and how it can permeate through an organisation based on the actions of its leaders.
In essence, culture isn’t as simple as a mission statement or corporate values, it is how employees act when their superiors aren’t around. Culture is the company’s character and it ultimately effects how each employee deals with all of their stakeholders.
Culture can sometimes feel like a second-tier checkpoint on investors’ minds, possibly due to its intangible nature or the fact that you can’t immediately see results by increasing or decreasing investment in it. Nonetheless, we at Evenlode consider it closely and have actively integrated it into our risk factor methodology as we believe in its importance in the long-term value potential of a company. Our risk framework consists of 10 risk factors and allows us to consistently highlight and monitor any opportunities or threats on a company’s horizon and we recently adjusted our framework to fully encompass and assess Culture in an organisation. Previously we concentrated solely on ‘Management Quality’ but over time we found ourselves considering the tenure, experience and attitude of management to be only a part of our analysis on how leadership affects long-term success. Hence, we tweaked the risk factor title to ‘Management Quality and Culture’ and now we actively spend time discussing whether the culture of a company might be a risk. We score our risk factors on a scale from A to E. This approach is deliberately non-numeric to avoid the tendency of grouping analysts’ scores and taking the average. Instead, it provokes discussions around the company in question, relative to all listed companies, and reaches a more collegiate decision.
A strong culture can manifest itself in a few ways and the culture that helps one company be successful is not guaranteed to work for another – for example, a company’s competitive advantage may lie in its branding of luxury goods. Therefore, an internal focus on frugality may not be the best fit and could even lead to an unintended divergence in the product quality that their customers look for.
A part of culture is captured well by the classic phrase ‘lead by example’ and the sense that an organisation is modelled off how top executives behave. More acutely though, it can be seen through internal promotions, supplier and customer retention rates and the ownership structure across the business. In order to assess the culture and leadership quality, we tend to ask ourselves a series of questions such as:
- Is product and service excellence at the core of their strategy?
- Do they consider multiple stakeholders in their approach?
- Are management realistic in their evaluation of risks and opportunities facing the business?
All of these have a common underlying theme: long-termism.
A great example of a shift in tone towards a more long-term focused strategy can be seen from the global pharmaceutical giant, GlaxoSmithKline (GSK). In 2018, GSK announced a shift in their R&D process to move from ‘progress-seeking’ to ‘truth-seeking’. Previously, their culture had been to reward progression along the R&D pipeline, which made their Phase-II or Phase-III prospects look attractive but was leading to resources being pumped into drugs with weak economics and efficacies. Ultimately, those resources and focus could have been put to better use and should have for the long-term prospect of the company. A multi-stakeholder approach highlights why the former plan was not sustainable as it was too focused on delivering on short-term metrics in an attempt to impress the market only. The new ‘truth-seeking’ culture looks to reward smart decisions and even, in instances where it makes sense - the termination of a project that could progress further but really shouldn’t. This approach to success will be welcomed and should lead to better outcomes for patients, employees and long-term investors.
The global pandemic has provided us with an opportunity to assess different company approaches to dealing with different stakeholders during a time of crisis. We have seen an interesting dynamic where companies were faced with tough decisions around their short-term profitability and longer-term sustainability. The actions that management take during these times can often clarify the priorities of the business which can then set the tone of the culture for the whole organisation which will stick with the company long after the crisis is over.
Encouragingly, we have felt that companies in our portfolios have acted as good stewards of capital through this time. The cessation of activity across many sectors left a handful of our companies in a ‘walking wounded’ state as exposures to industrials, retail and some areas of business services were significantly impacted. Our portfolio companies in this position tended to lean on Government support packages but at the same time, took the appropriate steps with regard to all stakeholders by also reducing Managing Directors’ salaries and postponing or cancelling dividends. Although it is clearly a difficult trading period for companies with this end market exposure, it is reassuring that they are considering all parties involved and aren’t just prioritising one.
Another element we have seen through the pandemic is businesses with a strong culture faring better, demonstrating how these periods can accentuate leadership positions. For example, the international recruiter, PageGroup has been able to acquire over 300, experienced, fee-earning employees which from estimates of their earnings in 2019 would add around 5% immediately to gross profits. This is testament to their handling of the pandemic, showing the benefits achievable when a company has a transparent and team-based culture. Bunzl is another good example, with around 40% of revenues exposed to a B2B food service segment and retail (think food packaging, disposal tables, catering equipment). Initially in April 2020, with an uncertain trading outlook, they accessed government support for employee costs, cancelled their final dividend and redirected 20% of Managing Directors’ salaries to charities. The long-term focus is key in this example, with management setting the tone with their own pay cuts, indicating a healthy top-down culture. Later, following unexpected outperformance from other segments, Bunzl decided it was appropriate to pay back the Government support packages and returned to being a dividend paying company, showing consideration for all stakeholders throughout the cycle.
To conclude, it is important to consider our position as a steward of capital for our investors and evaluate all the possible risks a company faces. The traditional role of capitalism is shifting and the single-minded focus on short-term profitability is no longer sustainable. Rather, a multi-stakeholder approach is becoming ever more appropriate, and a business need to not only consider shareholders, but all parties it interacts with, including suppliers, customers, communities, employees, and governments. The salience of those stakeholders can depend on the business, but the core theme is the meaningful shift away from the focus on just one and an emphasis on how internal culture will directly impact how the management and employees of any business will treat these different groups.
In times of crisis, it can become increasingly clear what is important to different management teams and this period helps us to analyse the different cultural positives and negatives of each company in our universe.
Charlotte Lamb, Investment Analyst
2020
Please note, these views represent the opinions of the Evenlode Team as of 2020 and do not constitute investment advice. Where opinions are expressed, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is not intended as a recommendation to invest in any particular asset class, security or strategy. The information provided is for illustrative purposes only and should not be relied upon as a recommendation to buy or sell securities. Every effort is taken to ensure the accuracy of the data in this document, but no warranties are given.