February 10, 2019

Strong culture: friend or foe

Manage Culture

by Elizabeth Arzadon

What exactly constitutes a ‘good culture’ is a hot topic in board rooms around Australia. Hayne’s Royal Commission held a largely implicit, but still searing conclusion: that the culture of our financial sector is broken. Whilst this message suggests system-level factors must lie at the heart of such widespread malaise, institutions would be naïve to think regulators, customers and shareholders don’t expect accountability for change to rest with individual firms. This requires Boards and Executive Teams to think about what good actually looks like.

Once upon a time, there was far more emphasis on the upside of culture – the idea that culture is a form of intangible capital that contributes to a firm’s value. Companies like Google and SouthWest are often cited as poster children for the powerful impact of culture on brand, innovation and customer service….and ultimately profitability and firm value.

In this vein, a letter recently penned by Cyrus Taraporevala, CEO of State Street Global Advisers, beautifully illustrates the two-sided nature of the culture coin. Taraporevala urges the Boards of major corporations to pay attention to culture, not for reasons related to values, conduct or ethics, but purely for its impact on sustainable financial performance. And SSGA isn’t the only firm in the industry examining culture through an investability lens. Late last year, a fascinating article in the Australian Financial Review gave insight into the investment strategy of US fund manager, WCM Investment Management, who also apply the concept of cultural ‘value’ in their models.

This emphasis on culture mirrors the same premise that guided thinking on how and why we assessed culture of client organisations during my (pre-GFC) time at McKinsey– a company’s performance will reflect alignment between culture and the source of its competitive advantage. Hence, a ‘good’ culture is one that aligns to its strategy. In many cases, this cultural framework no doubt identifies unexpected sources of outstanding value (the best kind for investors). However, as recent events have highlighted, this approach may sometimes overlook a critical consideration: characteristics related to risk culture.

No-one wants to admit it now, but Enron was also held up as a ‘best practice’ example of the financial performance that can be achieved when culture is perfectly aligned to strategy – in that case it was an aggressively performance-oriented culture aligned to an aggressive growth strategy. Great alignment, not so great outcome. Why? Because of the unintended behavioural risks created by the model, which we would now define as poor risk culture.

There are some companies in Australia with shareholders who might be wondering whether more visibility into risk culture would have altered their investment decisions. Certainly, share price trends suggest the question is a live one. It’s a problematic symbol when you see senior level resistance to very public feedback regarding the appropriateness of an institution’s behaviour. Such a cultural norm doesn’t bode well for managing the gap that can arise when public expectations fall out of step with legally-oriented conduct frameworks. Unfortunately, unless people are really paying attention, culture and conduct can be classic ‘boiling frog’ analogies: everything seems fine…until it’s not.

Many of the points highlighted by Taraporevala and WCM are well-grounded: there is no single ‘right’ culture, culture is about more than just values, and staff engagement is only the tip of the iceberg when it comes to the potential value of culture. But strategic alignment alone can be powerfully risky if that is the only dimension of culture senior leaders focus on. Now more than ever, firms need to be thinking carefully about culture as a driver of risk and performance, and if they really put their mind to it, how to mitigate cultural threats so that they turn into an opportunity. Now that might be a ‘good culture’.