FOOL ON THE HILL
Corporate Culture Impacts Profits

A company's culture can be a critical determinant of its long-term success. At firms with strong cultures, employees care about the company, each other, and customers. They share information and cooperate. They feel good about their jobs and are willing to go the extra mile. This can provide a meaningful competitive edge.

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By Whitney Tilson
August 21, 2001

In previous columns, I've discussed the importance of many different factors that one must consider when analyzing a company, including free cash flow, sustainable competitive advantage, strategy, and valuation. Today, I'd like to tackle something similarly important, yet more amorphous: corporate culture.

What is culture? The word has many definitions, but Merriam-Webster's website has the one I'm looking for: "The set of shared attitudes, values, goals, and practices that characterizes a company."

It's easy to think of companies -- Wal-Mart (NYSE: WMT), Home Depot (NYSE: HD), Starbucks (Nasdaq: SBUX), and Southwest Airlines (NYSE: LUV) come to mind -- with strong cultures. At such firms, I find, employees care about the company, each other, and customers. They share information and cooperate. They feel good about their jobs and are willing to go the extra mile.

This type of culture can provide a meaningful competitive edge. For examples, I highly recommend the classic Built to Last. A more recent New York Times article (free registration required) cites author Frederick Reichheld, who in the latest Harvard Business Review noted that "if a counter clerk increases his attention to customers by 5 percent, you will kick up profits by a shocking amount." Given this, it's not surprising that many companies with the strongest cultures, including the four noted above, are in retail or service businesses.

Dysfunctional cultures, meanwhile, can hamper a company's performance. Employee relations may be poor and characterized by an "us-versus-them" attitude between management and lower-level workers. (Think Dilbert.) A company may have difficulty attracting and retaining good employees. And customers may not enjoy the experience of working with the company -- and look elsewhere. Of course, profitability usually suffers.

And "strong culture" does not necessarily simply mean "fun work environment." For examples, look no further than so many dot-coms, which preached all the right values (and bought firepoles and lavish parties for employees) but practiced only one: "get rich quick, no matter what the cost." It's little wonder that employees defected in droves from these companies once it became clear the riches wouldn't materialize.

Charlie Munger on culture
At the last two Wesco (AMEX: WSC) annual meetings, which I attended and covered, Berkshire Hathaway (NYSE: BRK.A) vice chairman Charlie Munger, who is chairman and CEO of Wesco, spoke extensively about corporate culture, which he believes emerges from "practice evolution" -- or a company's efforts to improve its processes over time via constant reinforcement by top management -- and its importance in investing: "Common stock investors can make money by predicting the outcomes of practice evolution. You can't derive this by fundamental analysis -- you must think biologically." To illustrate his point, he gave a number of examples:

CORT Business Services
Referring to a Wesco acquisition last year, Munger noted: "We wouldn't have bought CORT if we didn't like the culture, which resulted from long practice evolution. It's like Enterprise Rent-A-Car. They both have a terrific culture, service and incentive system."

Tupperware
"Another example is Tupperware (NYSE: TUP), which developed what I believe to be a corrupt system of psychological manipulation. But the practice evolution worked and had legs. Tupperware parties sold billions of dollars of merchandise for decades."

Costco
"Costco (Nasdaq: COST) has the right culture. They promote from within. It's a wonderful place to work." (Munger is a director of Costco.)

General Re
"It's one of the best reinsurance operations in the world. It has a strong distribution network and culture -- a culture of intelligence and discipline." (General Re is owned by Berkshire Hathaway.)

Berkshire Hathaway
"There are certain virtues that are common in all of Berkshire's subsidiaries. We don't create them -- we select companies that have them already. We just don't screw it up.

"There's a lot of human love in building at least some businesses and some people who own businesses love them. They don't want to sell to a financial buyer who will dress it up and strip it down. When we buy a company, we don't tinker with winning businesses. So, for some sellers... Berkshire Hathaway was the only acceptable buyer.

"If you want a culture like ours, I don't know anywhere to get it if not here."

Roots of strong cultures
As Munger correctly notes, strong cultures do not develop by accident. Instead, they are created over time. I recently spoke with senior managers at two companies whose cultures I admire, and asked them how they create and nurture their cultures.

Steve Markel, vice chairman of Markel Corp. (NYSE: MKL), answered:

"Having the right culture is a critical element of building a business of any sort. We spend a lot of time thinking about it. We call it 'The Markel Style.' Key tenets are openness, honesty, delegation of authority and holding people accountable. It's imprinted everywhere, such as on the inside cover of our annual report. It's repeated over and over.

"As management, the key is to practice it. When you have a decision to make, you it line up against the values. You can't work on value #1 on Monday and value #2 on Tuesday. You have to use all the values every day."

Bruce Nelson, who became CEO of Office Depot (NYSE: ODP) last year, echoed similar sentiments:

"I have core personal beliefs about people and organizations. I have a set of values that people aspire to and believe in, and I've tried to articulate them from my first day as CEO.

"One of the first things I did as CEO was take the senior leadership through a series of sessions to develop a common set of values and make sure they were understood and constantly reinforced. Then we presented this, over the course of six hours, to the over 40,000 employees in North America. We asked them for input and got incredible feedback, which we incorporated. It was a transformation process."

When asked to describe the impact of these efforts, Nelson replied:

"I've been taken aback by the progress. Across the board, there is a much higher retention rate from a year ago; in some cases, double. Our customer service indices are also way up across the board. I also sense that our employees have more hope and confidence, and that morale is substantially higher than it was nine or ten months ago."

Conclusion
Thinking about corporate culture might sound somewhat "touchy feely," but I would argue that few characteristics are more important to a company's -- and stock's -- success, both in turnaround situations like Office Depot's and in building and maintaining a company's competitive advantage, as in the cases of Markel, Berkshire Hathaway, and others.

Don't believe me? Take a look at Office Depot's stock chart since early January (when Nelson announced his turnaround strategy) and Markel's and Berkshire Hathaway's over the past decade or more.

In future columns, I will share some thoughts on how to evaluate a company's culture, and also take a look at how some companies use innovative compensation systems to foster the right culture.

-- Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Berkshire Hathaway, Office Depot and Wesco at press time. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/