Investment Process: The Role of Analyzing Company Culture

Company culture is important. How should investors think about and analyze it?

Analyzing management’s alignment and competence is widely accepted (especially in quality/compounder circles) as an important part of the research process. Something I see less often, but that I have come to believe is at least as important, is analyzing the overall culture that exists in a firm. And to be clear- I see plenty of talk about it, but I suspect that rigorous analysis and deep thinking in this area may be a source of competitive advantage for long-term investors.

I think one of the reasons for this is that the culture can be somewhat abstract and difficult to uncover compared to more concrete aspects like alignment and competence. While there is nuance to each company’s situation, I usually feel like I can get a pretty good handle on management’s alignment by a review of the proxy statement, and can assess their competence with a reasonably high degree of confidence by studying what they have done in the past and what decisions led them down that path.

Analyzing culture is hard because there is no single place to look. There’s few ways, if any, of quantifying it. Whereas we can say management owns x times their salary in stock, or that the company has outperformed the market by x% since they took over. Nevertheless, I think it’s an aspect that is important to think about.

John Wooden said that character is what you do when no one is looking. Culture can be thought of as the character of a company. It informs managers and front-line employees on what decisions to make in day-to-day situations. Or as @breadcrumbsre put it, corporate culture is the quality of ALL decisions (even those made by a janitor). This contrasts with the management team, where the focus is on the quality of strategic decisions.

The Culture Must Align with the Moat

“We put a huge premium on corporation's culture. That doesn't mean we just want shareholder friendly management teams. We want to understand the DNA of the business. We want to know what the core values of the business are, and how those core values relate to the competitive advantage.”

– Paul Black of WCM Investment Management on Capital Allocators podcast (link).

Different cultures are going to serve a company more or less effectively depending on both the business model and the moat.

Cliff Sosin talks about this in his interview on Yet Another Value Podcast.

“Once you learn how an organization is built, it tells you what it can do, but it also tells you what it can’t do. Once you learn that what you have is a football team, you know they can’t win at golf. Boeing will never be nimble and dynamic. It can’t. And if it were, it would be a disaster. I wouldn’t want to get on the airplane. At the same time, Starbucks will never be able to produce a carbon fiber 787. It just can’t.”

As alluded to above, this sort of analysis is also a focus for Laguna-beach based WCM Investment Management (who is looking to hire a culture analyst). On the Capital Allocators podcast, Paul Black gives a similar example, comparing early Walmart with a railroad (lightly edited),

“Sam Walton really embraced the notion that you’ve got to make people happy. In those days, it's different now, but you've got to pay those people well. You've got to tie them into the bottom line, and he kind of built this culture where people just loved coming to work and they had a lot of fun doing it. And as a result, they took on these old, stale kind of bureaucratic, centralized organizations and that works for a retailer, but does that...Do you really need happy employees to run a railroad? Probably not, right? You're probably not all about, hey, I want a bunch of yahoos running around throwing parties. You want people that are highly accountable, probably think a certain way, more linear because it's all about delivering on time product in an efficient, cost-effective manner. So in Canadian National or Canadian Pacific railroads, you've got to pay people more than you would in a retailer, but high levels of accountability, there's a high cost of failure there, so probably a lot more in different stresses, very different corporate culture you need for that than you need for retailer.”

As another example, consider Spotify. In a recent interview with Tim Ferriss, Daniel Ek talked about the greater importance of speed of iteration compared to quality of iteration. He thinks the culture at Spotify should be less about “having some godlike ability to see the future before anyone else” and more about being able to learn and adapt quickly to a rapidly changing world. This makes sense in the context of a company that builds a consumer-facing, non-critical product. But learning as you go isn’t going to work for Boeing. Neither is taking huge steps in new directions on a regular basis a good idea for a company like LVMH that needs to preserve their brand image.

Interestingly, this also shows that there isn’t necessarily a single “correct” culture, as Ek juxtaposes this approach with visionary leaders like Steve Jobs (though one could argue how accurate that characterization of Apple is. But at least with the iPhone, there was certainly more of a leap to give customers what they didn’t even know they wanted, rather than incremental innovation built on prior technologies and ideas (pirating music, instant gratification, personalization, etc.).

Seizing an Advantageous Position

@SecretCapital_ recently posed a very interesting question on Twitter: “Can exceptional UI/design be the source of a moat?”. My answer to this was that this can only be the case if you maintain that UI/design lead, which can be uncomfortable to bet on. It requires tons of conviction in the leadership team as well as the culture of the company. It needs to be one of the kinds of companies described in my previous article that focuses intensely on aspects like these and aggressively innovates to stay ahead.

What is more interesting, in my opinion, is that it can drive substantial customer acquisition that can ultimately lead to a real moat such as network effects, scale economies, switching costs, etc. The below image is from Hamilton Helmer’s 7 Powers. If strong UI/design can help companies climb that takeoff curve faster than the competition, thus securing the Power type(s) related to that climb, then strong UI/design can be a key point in an investor’s competitive analysis.

So while I wouldn’t consider it a true moat or source of Power, a superior customer experience can certainly be a good way to get you to Power. And understanding company culture is key for evaluating the probability of the UI/design advantage persisting long enough for the company to get there.

Analyzing Culture

So you’ve decided analyzing culture is an important part of the investment process. Now what?

I have found that it is one of the more difficult aspects of research. It’s not quantifiable. Companies often don’t talk about it publicly in any meaningful way (though they all speak on it superficially). And even if they do, you don’t know whether what they are saying is true.

Lastly, there is some factor of this sort of work feeling superfluous, even though it is not. There’s no one thing that you can point to that shows what a company’s culture is. And everyone talks about it, so it raises the question- “is this really differentiated? Is this an area we can get an edge in?”

There are a couple of options:

• Analyze the company’s track record. Past actions, successes, and failures can be indicative of whether a company has historically had certain characteristics. Have they innovated relentlessly? Have they constantly improved their product? Have they maintained a high NPS score? How do they respond to failure? Have they operated a railway or manufacturing business at high efficiency for decades?

• Speak with former employees. While a wide sample set is required, this is a good way to get an inside glimpse of what the company values. You can also watch employees in YouTube videos, listen to them on podcasts, and follow them on Twitter. This is especially effective for employees that have worked closely with senior management. What kind of tone do they set? Do they walk the walk?

  • Glassdoor employee reviews are to be taken with a grain of salt but can be helpful. Especially interesting to look at them across departments/roles.

  • Tegus can be a great resource for this (but I also wonder if it is becoming less of an edge and more just table stakes given the rapid adoption of the platform in recent years… I guess, like anything, it depends what you do with the info and how you weigh it)

• Speak with management. Some questions that WCM suggests:

  • What would you tell a friend about how to succeed at your company?

  • What do new hires struggle to get used to?

  • What are some difficult scenarios you have been in?

  • Tell me about your failures and mistakes

• Study senior leaders (especially if there is an owner-operator). What makes them special/different? If this was a seed stage company with no product, would you invest with them?

• Look at job postings and job descriptions. What are they looking for? What’s important to them?

A couple more important things to mention:

• The longer your investment horizon is, the more this matters. Again, this is because the culture of the company will determine how people make decisions. And that adds up in a big way over time. As Fred Liu put it, “When you're investing in a business for 10 years, the only things that don't really change are the management teams and the cultures that they've built.” If you’re time horizon is only a couple of quarters, this is less likely to impact your results.

And lastly, there are a number of challenges and other considerations relating to this approach that I should note and would be eager to hear your thoughts on:

• It’s largely unquantifiable. There’s likely to always be a nagging voice in the back of your head asking, “how do I know I didn’t just talk myself into this narrative?” The more data points you can string together from the above, the better. Another way to correct for this is refusing to settle for just “good”. For the culture aspect of a company to really add to your conviction in an investment, you should be blown away. Unless your looking at sleepy, industrial micro-caps, there is probably a reason why the management/culture of that company were able to get in front of you in the first place. Is the culture really exceptional relative to the playing field of companies you are looking at/that they compete with?

• Certain companies have more public material (books, podcasts, news articles, etc.) out there on them than others

• If you’re investing in a company in the early stages, their ability to maintain the culture as they grow becomes a new question and point of investigation.

• Just like with moats, it’s up to you how important you want this to be in your process. Are you open to investing in average cultures? Good ones? Only great ones?  

Disclosure: None of this is investment advice. I may have positions in securities mentioned.