Cultivating Culture: The importance of a good corporate culture

Culture is how an organisation thinks, acts, and interacts. A good corporate culture drives superior business performance - it motivates and retains the most talented employees who ensure sustained strategy execution. It also promotes equality in the workplace and supports both social and industrial changes as they occur. When searching for high-quality companies, assessing a firm's corporate culture is critical to evaluating the success of an organisation and its long-term potential.

A strong corporate culture cannot be built overnight, it will evolve and permeate over time and requires strong leadership and employee buy-in. While it's difficult to define, it has an outweighed influence on a firm's long-term success.

Good culture provides both employer and employee with an environment that encourages and fosters communication, collaboration, innovation and social harmony. This helps to ensure high productivity levels while maintaining focus and motivation.

A good culture does not replace a corporate strategy, but it should help to facilitate its execution and encourage a strategy that is continually evolving and improving.

Companies that can cultivate such an environment may benefit from a high degree of buy-in from their employees as they put the collective greater good of the company ahead of their own individual aspirations.

A high degree of alignment allows these organisations to thrive, driving positive financial outcomes, ultimately leading to their people being better rewarded.

What drives a good corporate culture?

A good corporate culture begins at the top. It needs to be a key priority for senior leadership, who need to understand and be aware of the benefits that a good corporate culture delivers.

Culture is central to long-term performance - the executive is essentially the culture guardian. Culture is the most critical enabler of successful strategy implementation and should be protected at all costs.

When senior management is focused on ensuring a good corporate culture, it trickles down to middle management and other employees to become firmly embedded within the organisation.

The tenure of management is an important consideration when assessing the presence or absence of a healthy corporate culture, as it provides us with confidence that the management team holds the skills, resources and experience required to continue to nurture their culture through all business cycles.

Not all companies are filled with seasoned leaders, so in these cases, it is important that any new leader recognises the importance of corporate culture and the influence it can have on the long-term performance of the company.

Companies with a poor corporate culture are less effective in executing their strategic goals. In some instances, painful and disruptive decisions may be made to remove employees for the greater good of the organisation. See our previous article on James Hardie (ASX: JHX) and the steps taken to protect their culture.

What does a good corporate culture lead to?

A positive corporate culture leads to higher productivity levels and better financial outcomes. An organisation with a strong and positive corporate culture can more readily increase its overall productivity, reducing labour force churn rates while delivering better, more sustainable outcomes.

For any business, improved productivity creates a virtuous cycle, boosting morale and creating a culture of excellence - a competitive advantage in itself.

Conversely, when workers waste time on tasks unrelated to driving revenues or profits, they (negatively) impact the organisation and eventually, they leave the organisation, are dismissed, or worse, they stay and disrupt others while dragging down the firm's culture.

For many businesses, people are one of their most significant capital outlays, and are one of the most important areas of investment.

Normally it is easy to measure the ROI of an asset; however, it is more challenging when assessing the ROI of the workforce. Staff costs are generally a high percentage of overall variable costs in a firm, so the importance of extracting solid returns is critical.

Moreover, when a company has a positive corporate culture, employees become chief promoters of the firm. For many stakeholders (customers, suppliers, and the broader community), this level of support from their working base emphasises the quality nature of the business.

This is readily observable by those outside of the firm and can result in reputational value being added, driving people, customers, partners, suppliers, and potential employees, amongst others, to the company, further driving revenue, reducing operational friction, or both.

How to assess corporate culture?

Measuring or assessing organisation culture can be difficult as the benefits of a strong corporate culture are often intangible. Some cultural indicators are online staff satisfaction surveys, company churn rates, net promoter scores, or, quite simply, the financial performance of a firm.

One internal mechanism for measuring the corporate culture is staff engagement levels and net promoter scores. These are indicators of how interested the workforce is in not only talking about the positive attributes of a firm but also highlighting where things can improve.

In our experience, culture is also an attribute that is proudly displayed by those who possess its positive manifestation, and conveniently brushed over when it is lacking or poor. Companies tend to highlight when a culture is good, making senior managers available for meetings, or highlighting positive workplace stories.

On the contrary, when a culture is bad or toxic, management tends to restrict access and try to hide evidence of the fact that people dislike working in the organisation. Often the information presented (or lack thereof) provides us with insight and causes us to look deeper under the hood.

Not all companies that perform well have strong or positive corporate cultures. However, if the corporate culture is bad, it often leads to issues and missteps within the organisation, which can impair the enterprise value of the firm.

Cultural Case Studies

Sometimes, it is difficult to identify a bad corporate culture when a company is performing well, but when we do, our preference is to first engage with the company, while divestment is possible if strong corrective actions are not made by the company.

Below are two cultural examples, one emphasising cultural excellence, and the other demonstrating how strong, decisive actions can reorientate an organisational culture in the right direction.

Road to Recovery

Rio Tinto (ASX: RIO) offers an example of where the company performed well (financially), but a terrible corporate culture under the previous CEO and management team led to serious operational breaches.

For Rio, the breaches resulted in the Juukan Gorge destruction, and they were also responsible for a toxic workplace culture. While the company continued to perform well, generating record earnings, these events took away from its financial performance resulting in a share price that underperformed.

Rio’s detailed study of its own workplace revealed a very toxic workplace culture that had evolved over many years. The report was disappointing for the Board and senior management team but it helped to drive drastic changes with all management and employees embracing a new cultural outlook.

For us, Rio’s transparency and willingness to change is one positive element of its culture (albeit a recent one). Rio’s courage to investigate the situation and publicly reveal the findings demonstrates strong governance practices and should be applauded.

Rio’s current Board and Executive team are highly motivated and genuinely focused on making positive changes to ensure its employees operate in a sustainable way while operating responsibly within environmental and social mandates.

Rio’s ‘Report into Workplace Culture’ followed multiple ESG breaches, underscoring how a toxic culture can influence decision-making, resulting in suboptimal outcomes. While the financial performance of Rio was excellent during the same period, the report revealed that many employees were dissatisfied and disengaged.

The result of this poor culture was productivity issues, poor decision making and generally unhappy people both at and outside of the workplace. The indirect costs of this poor corporate culture were significant, demonstrating why swift action is necessary.

When a toxic culture exists, and this manifests in situations such as the Juukan Gorge heritage site destruction or workplace harassment issues, leaders may find themselves in a position that can drive substantial (positive) changes for the betterment of the organisation.

The appointment of the new CEO, Jakob Staushol and then Kellie Parker as the Head of Australia were significant decisions and demonstrated the company's intention to build a better culture.

Rio was squarely focused on rebuilding its corporate culture to ensure better future decision-making. We expect that this cultural change will drive better financial outcomes, and ensure lower staff turnover rates and lower incidents at the workplace.

Quality Sounds

Cochlear Limited (ASX: COH) is a company that was founded in the early 1980s. It has a rich history in R&D and has long been an employer of choice for those wishing to access engineering resources and support in the hearing space.

Many of the senior management team have been at the company for decades, including the CEO, CTO, Head of North America and the Head of EMEA. Several other leaders have significant tenures, as well as many employees, who have been with the firm for a very long time.

Cochlear’s culture centres around research and innovation. The company’s significant spending on technological advancements has resulted in continuous innovation that has driven positive change within the industry. The result of this has meant that it has attracted many high-quality people while fostering an innovation-based culture.

By ensuring a positive cultural workplace, centred around research and innovation, the company has successfully produced leading-edge technology in the hearing implant-related field. It has dominated the market with a leading market share of nearly 70% (in implants), a position that competitors can only dream about.

Moreover, the effect of this has led to superior financial results and share price performance over a very long period of time. It can be largely attributed to the long tenure of management and the culture they have created within the organisation.

People Power

At ECP, we seek to identify companies with predictable earnings streams that are growing their economic footprint. For all companies striving to grow their economic footprint, it is important to focus on corporate culture and the benefits that a positive culture can bring to an organisation.

The true test of a positive corporate culture is not only in the upcycle but, more importantly, in the downcycle, a time when a positive corporate culture truly makes a difference in motivating and retaining employees.

Company culture is a critical enabler of successful strategy implementation. Ensuring a respectful and healthy working environment is essential for long-term performance. Finding companies that excel in this area will ensure greater conviction in an investor's belief surrounding other fundamental areas of the investment case.