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Culture & Growth - Part 1
How company culture predicts long-term growth and prosperity.
Over 2 years ago, Benjamin Laker wrote in a Forbes article :
Companies with strong cultures have seen a 4x increase in revenue growth.
Furthermore, companies that have appeared on Fortune’s annual 100 Best Companies to Work For list also see higher average annual returns, with cumulative returns as high as 495% instead of 170% (Russel 3000) and 156% (S&P 500).
Are such audacious claims actually credible?
Unfortunately for us, the links he had provided to support his statements are no longer available.
Studying the relationship between culture and performance has been done for a long time.
In 1992, research conducted by Rutgers University in New Jersey delved into the interplay between culture and premium growth rates among 11 insurance companies. Their findings were:
A strong culture, regardless of content and a substantive value placed on adaptability, is associated with better performance for two to three subsequent years on both criterion measures.
Study link here.
Perhaps the most quoted research on this has been completed by Denison, who looked at 127 companies from 1995 to 2010 and found the below results:
Today, let's delve into the significance of culture and explore a favoured proxy for culture evaluation and its growth correlation on the ASX.
Why does Culture matter so much?
In his excellent book "Common Stocks and Uncommon Profits," Phil Fisher begins by presenting a 15-point checklist outlining what he believes contributes to a promising investment opportunity. After revisiting the book, I've crafted a summary post (still sitting in my drafts), and here, I'd like to highlight three of Fisher's points that are particularly relevant to our discussion:
Outstanding Labor and Personnel Relations: Fisher's seventh checklist point emphasises the significance of strong relationships within a company.
Outstanding Executive Relations: Point eight underscores the significance of high-quality executive relationships.
Depth in Management: Fisher's ninth point underlines the need for depth in management. A company with a robust and skilled management team is better equipped to handle various situations, ensuring continuity and adaptability.
Interestingly, these three checklist points (7, 8, and 9) all revolve around the concept of company culture. As far back as 1957 (arguably, Fisher was ahead of his time), astute investors recognised that a company's culture offers insights into its long-term growth potential and prosperity.
Getting to the nitty-gritty of operations, I've gained valuable insights, (much like you I’m sure), from my experiences working at and founding companies, highlighting the immense influence of culture. Here's my perspective:
One of the foremost reasons why culture holds such significance is its ability to attract top talent. Senior operators will actively ensure their personal values align with your company's ethos. A lackluster company culture can create hurdles in securing adept senior leaders.
While junior high performers might not scrutinise culture extensively before joining, they quickly assess the environment upon arrival. If the culture doesn’t suit, they will be out the there before onboarding is finished.
Thriving companies experience rapid growth, and need to hire quickly. This acceleration is pivotal for sustained expansion. However, the challenge lies in maintaining culture and avoiding bad hires, which becomes more difficult.
Ultimately, culture acts as the cohesive force, uniting the team during both triumphs and challenges, while also providing direction during crucial choices.
Culture Strain: Transitioning from one phase (with fewer than 50 employees and ongoing product-market fit efforts) to a balanced Go-To-Market model induces cultural shifts, particularly in decision-making between GTM and product strategies. This can lead to a lot of early employees leaving because “things aren’t the same anymore”.
Evaluating workplace culture from an external perspective is challenging and requires more than just a single tool.
The most accurate way to understand a company's culture is by experiencing it firsthand through employment. However, since most of us won't have the opportunity to work at numerous companies to build a comprehensive portfolio, we have to default to alternative methods.
Engaging in conversations with current and former employees often proves to be a valuable approach. The downside is that investing time in these conversations might not always yield desired results (been there, done that).
Glassdoor provides a partial glimpse into a company's workplace culture.
My previous employer, Salesforce, admitted to using Glassdoor to evaluate the quality of companies to acquire.
CNBC hypothesised, over 5 years ago, that “the internal rating of its chief executive by employees on Glassdoor” could have been used a clue of upcoming challenges at the company.
One of the highest quality pieces on this has been written by Jason McPherson
Founding Scientist at Culture Amp in 2017, who highlighted that “Higher engagement and product belief was associated with 51% higher share price growth”.
Culture eats strategy for breakfast
Limitations to look for
A common belief in the world of investing is that once a technique gets acknowledged and becomes part of every investor’s process, the benefits of it get arbitraged away. If everyone else is looking at Glassdoor reviews, than surely this variable gets built-in to the consensus pricing.
Whilst that may be true, the counterargument here is the hypothesis that a strong culture will outlast most of the other growth drivers. You can copy product features, but you can’t copy outstanding humans.
When looking at Glassdoor for small companies, one needs to be particularly mindful of:
Low number of reviews. When the number of reviews is insufficient (e.g., below 5), I am inclined to disregard the overall rating entirely. 5 individuals internally could obscure the actual picture. Nonetheless, parsing through individual reviews can still yield insights.
5 star, and 1 star reviews. The extremes are typically exaggerated. Some 5 stars reviews tend to get done by internal stakeholders looking to boost the brand, and 1 star reviews can be submitted in the bad leavers still influenced by the cloud of emotions that are running wild.
All reviews from same role type. If all the reviews are done by salespeople, that give us nothing more than a partial view on the culture of a team, not the company.
I’ve used the curated a selection of approximately 150 companies from my broader and compiled their Glassdoor ratings.
I have excluded those with fewer than 5 ratings, and I've specifically marked those with less than 10 ratings in red, as these tend to offer comparatively reduced insights.
Here are all with 4 and above:
Are winners growers?
To look at this, I removed all that had below 10 ratings. For growth, I went high-level, back of the napkin, and averaged out the last 3 financial year end results to come up with a ballpark average growth rate.
Only 1 outlier. The first thing we note is that there’s only 1 company in the top 20 with growth rate below par.
Reckon (RKN.ASX) is a unique business focused that’s historically focused on growing, scaling and selling software businesses. They now have a track record of doing this (once in 2017, again in 2022), so evaluating them via top line growth can be misleading.
The correlation exists. Given that 14 out of the 20 businesses are above average growers (20% or more range), we can conclude that a strong culture could be linked to strong growth.
Correlation or Causation?
The hardest part about this is distinguishing between correlation and causation.
In a rapidly growing company, employees experience a profound sense of achievement and progress. There's nothing quite like winning to cultivate a powerful, positive culture. However, challenges arise when growth begins to decelerate. This becomes the true litmus test for your company's culture. Employees may perceive a lack of direction and purpose. Alternatively, they might kick their efforts into overdrive if they are fully bought in to the vision.
In the upcoming article of this series on Culture, I will delve deeper into the topic of correlation versus causation.
Additionally, I will provide a more in-depth exploration of five companies listed in the above sheet, analysing their high Glassdoor ratings and attempting to discern the extent of Glassdoor's reliability.
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