28 Sep 2011  Research & Ideas

The Profit Power of Corporate Culture

In the new book The Culture Cycle, Professor Emeritus James L. Heskett demonstrates that developing the right corporate culture helps companies be more profitable and provides sustainable competitive advantage.

 

Corporate culture is often thought of as a hard-to-define, or soft concept in management circles. Soft not in the sense that it isn't important—most CEOs will tell you that their ability to inculcate values and mission into the DNA of a firm is among the most important work they do.

No, the problem arises because little research has been targeted at trying to quantify its importance on performance. In his new book, The Culture Cycle: How to Shape the Unseen Force that Transforms Performance, HBS Professor Emeritus James L. Heskett attempts just that. "Organization culture is not a soft concept," he says. "Its impact on profit can be measured and quantified."

Heskett finds that as much as half of the difference in operating profit between organizations can be attributed to effective cultures. Why? "We know, for example, that engaged managers and employees are much more likely to remain in an organization, leading directly to fewer hires from outside the organization," Heskett writes in the book. "This, in turn, results in lower wage costs for talent; lower recruiting, hiring, and training costs; and higher productivity (fewer lost sales and higher sales per employee). Higher employee continuity leads to better customer relationships that contribute to greater customer loyalty, lower marketing costs, and enhanced sales."

Whatever it is and whatever its benefits, a recent survey showed that many American companies do a poor job of creating effective cultures. A 2010 Conference Board study revealed that only 45 percent of US workers were satisfied with their jobs—the lowest level in the history of the survey. Our Q&A with Heskett begins with that dour figure.

Sean Silverthorne: Why are workers experiencing less job satisfaction?

A: Jim Heskett: One can only speculate on the sources of low job satisfaction. It could be a product of unmet expectations, possibly due to inadequate attention by firms to hiring, training, and subsequent management. Those entering the workforce in the past 10 years or so may have had unrealistic expectations regarding things such as opportunities for personal development, frequent and timely feedback, and advancement, especially in organizations that are contracting rather than expanding. It could be a product of the fear of job loss even for those still holding employment. And of course, real wages have not been increasing, although compensation often falls rather low on the list of things that employees seek out of the employment "deal."

Q: What is the culture cycle?

A: The culture cycle begins with the establishment and communication of shared values and behaviors, and includes:

  • the careful selection of employees who are believers in these values and in establishing "how we do things around here";
  • the development of realistic expectations in the minds of new employees and meeting them in ways that establish trust, engagement, and "ownership," which are the foundations for the successful implementation of whatever policies and practices are necessary to execute a given strategy;
  • policies and practices that lead to a learning, innovative organization;
  • measurement of the results in terms of things such as employee retention and referrals, returns to labor, and relationships with customers (producing loyalty and customer "ownership") as well as innovation and financial performance.

If the organization doesn't measure up on these dimensions over some extended period, it may be necessary to review shared values and behaviors as part of an effort to change the culture. This sounds like a lot, but the culture cycle provides a foundation for the creation of an organization capable of setting high goals and meeting them.

Q: Your research produces an eye-opening number, that as much as half of the difference in operating profit between organizations can be attributed to effective cultures. Why is this true-how does culture affect the bottom line?

A: The point is that organization culture is not a soft concept. Its impact on profit can be measured and quantified. And in organizations with large numbers of customer-facing employees, the sum of the effects of employee turnover, referrals of potential employees by existing ones, productivity, customer loyalty, and referrals of new customers attributable to culture can add up to half of the difference in operating income between organizations in the same business.

Current and former CEOs such as Lou Gerstner (HBS MBA '65) and Sam Palmisano (IBM), Ken Iverson (Nucor), Tony Hsieh (Zappos.com), and Scott Cook (HBS MBA '76) (Intuit) who believe strongly in the importance of culture have been hinting at this, so I went out into the field and collected data that demonstrate it.

Q: You mention Scott Cook. He once told me that on his first day as cofounder of his new two-person company, Intuit, he started by writing an employee handbook. Your work would seem to confirm the rightness of that decision, that culture develops in the start-up phase and is difficult to change after that. How should entrepreneurs starting a company approach creating a culture?

"Cultures develop with or without conscious effort"

A: Cultures develop with or without conscious effort. They generally reflect the beliefs and behaviors of the founder of the organization and are often not codified until some years later after the success of the start-up."

More founders would be advised to emulate Scott in giving thought to the kinds of cultures they are trying to create. As I point out in the book, "The task of nurturing and changing culture is an important responsibility of the CEO; it has to be led from the top. If you don't believe it, don't do it. Let the culture shape itself. It will represent just one more 'unknown' to deal with, albeit an important one."

Q: Business is becoming more global, certainly. What are the cultural challenges faced by firms with global operations, and how can these challenges be overcome?

A: The basic question to be faced is whether the organization will be run as "one company" with a common set of values, such as at Mexican-based cement and concrete producer CEMEX; as a "multilocal" culture, such as at Danish-based facility services provider ISS; or as some combination of the two—typically in a holding company like US-based marketing services provider Omnicom with a number of subsidiaries, each with its own culture.

A one company culture may be appropriate in a single company selling products of a relatively uniform, low customer involvement nature where it is important to move people of different backgrounds and nationalities around the world as part of their development. In contrast, high involvement products or services such as marketing services have to be delivered by organizations that adapt themselves to local needs and cultures. If good managers are to be moved around the world as part of a "one company" strategy, they have to be hired with that in mind and provided with training in language and customers, time to become acclimated to new environments, and support for their families as well.

Q: How can a CEO spot a dysfunctional or at least disintegrating culture? What should be the first steps to fixing the problem?

A: A CEO in this situation should be tracking and managing by the numbers—the nonfinancial numbers. By the time financial results turn downward, it is far too late to act. Financial numbers measure the past and lead to "rearview mirror management."

The numbers that predict the future are the Four Rs-employee retention and referrals, returns to labor (productivity), and relationships with customers (exhibited by loyalty and ownership behaviors such as referrals)—as well as measures that track innovation. Once these numbers start to turn downward, it's time to reexamine organization values and behaviors, hiring practices, and other elements of the culture cycle.

Read an excerpt from The Culture Cycle: How to Shape the Unseen Force that Transforms Performance

About the author

Sean Silverthorne is the editor of HBS Working Knowledge.

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Comments

    • Anonymous

    Current and former CEOs such as Lou Gerstner (HBS MBA '65) and Sam Palmisano (IBM), Ken Iverson (Nucor), Tony Hsieh (Zappos.com), and Scott Cook (HBS MBA '76) (Intuit) who believe strongly in the importance of culture have been hinting at this.

    Let's not forget to add:

    J. Skilling, Enron, (1979) Eugene Plotkin, Goldman Sachs, (2000) Michael Rigas, Adelphi (1976) Martin Siegel, Drexel, (1971) Kirk Shelton. Cendant Corp, (1978) Brad Stinn, Friedman's, (1981)

    Most CEOs will tell you that their ability to inculcate values and mission into the DNA of a firm is among the most.

     
     
     
    • David White
    • Principal, Ontos Global

    First, as a culture researcher and practitioner I am excited to hear of Dr. Heskett's new book and renewed claims of a link between profitability and culture. I look forward to reading it.

    On the basis of this interview, however, I am disappointed. Dr. Heskett continues to put forward a position that remains, regrettably, unsubstantiated in the culture literature, at least in academic disciplines also seriously concerned with organizational culture such as psychological anthropology and social psychology. The first is that culture is an object of normative control to be shaped and changed by CEOs (through values, hiring practices and the like), much in the same way that a CEO might determine brand strategy or a budgeting process. The second is that culture is shaped by founders. Oh that it were that simple! Unfortunately, there is little evidence in these literatures that culture responds in a linear and direct fashion to leader intervention. And there is even scarcer evidence that founder values are sustained in a culture beyond the first few years.

    The problem is both ontological and epistemological. The ontology problem is the same one that has vexed anthropologists for 100 years: what is culture? Unfortunately, management thinkers have not dodged the bullet: 'culture research' continues to posit reductionist definitions (culture is values, culture is norms, culture is employee behavior, etc.) and then put forward unassailable "proof" that variables like hiring practices, leader values, etc. will conclusively and indelibly shape that culture and, therefore, by simply pulling the culture lever all good things will follow.

    Even if we accept Dr. Heskett's definition of culture as 'the way we do things around here' - a contemporary working definition posited by many researchers and practitioners, myself included - then there is also the epistemic problem: culture researchers must reasonably account for how they know what they claim to know. Culture variables such as dominant professional culture, dominant national/regional culture, task and regulatory environment, historical inflexions in firm history, market forces, multinational fiduciary structure, and other variables surely shape 'how one does things'. Yet, what accounts for what?

    Simply put, the culture problem is much more complex than the management literature would have us believe. And at least from what I have read so far, I am not convinced Dr Heskett's effort will lay these problems to rest. On the other hand, if the market continues to consume and believe that culture can be managed like any other dependent variable in business, those of us in the culture business will stay in business for a long time.

     
     
     
    • Gerard Bremault
    • CEO, The Centre for Child Development

    I am reminded of the sage quip of a former Board Chair and Harvard Business School Alumnus, Bill King who, during my early efforts to effect an organizational "turnaround", frequently reminded me that, "Culture kills" and by implication that "Culture enables". I couldn't agree more with Professor Heskett's assertion that, "This sounds like a lot, but the culture cycle provides a foundation for the creation of an organization capable of setting high goals and meeting them." While deep and painstaking, deliberate positive culture change has been key to fundamental improvements in our organizational performance metrics over time.

     
     
     
    • Guy Higgins
    • Principal, Performance2

    I found this interesting, but not surprising. I think that culture is a huge determinant of performance. I am also interested in discovering whether anyone has investigated the effect a culture has on two specific behaviors (for lack of a better term): * cognitive diversity -- how does organizational culture deal with different (hopefully very different) ways of thinking and therefore ways of perceiving and solving problems and making predictions? Is there a force driving to homogeneity of thought (super cognitive identity)? Does it create a downside? * complex adaptive behavior -- how does organizational culture help or hinder that organization in dealing with and adapting to the changing environment? Does cultural homogeneity impede (or enhance) the ability of the organization to adapt? While not completely independent of the cognitive diversity question, I think this is a separate area.

    I would be very interested in learning about any research dealing with these two areas.

     
     
     
    • G.P.Rao.
    • Founder Chairman., Spandan, Foundation for Human Values in management and Society, India.

    Being a person interested and involved in the process of inculcation of human values as integral to work ethic and strategic management, I for one welcome the thought processes of Prof. Heskett - his belief that the impact of values on organsiation culture cane be measured and quantified. My own experience is that a more critical issue is the role of CEO or top management in the process of, so to say, 'accultarisation' of their organisation. Their interest or role generally varies from negative to more than 100 percent to indfferent to zero. Negative prior to the inculcation; Over enthusiam or more than 100 per cent at the intitial stages; Indifferent at the later stages; and zero after the completion of the first cycle of inculcation process (in collaboration with external facilitator).

    Through this column I seek the experienecs and the manner in which the issue has been resolved by Prof. Heskett and others.

     
     
     
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited

    Culture is a variable and not something tailor made or scientifically definable to suit all leaders, corporates and situations. Every leader creates a corporate culture in keeping with the laid down basics and for achieving the organizationa goals. After setting his parameters, he lets all others, particularly the freshers, know what has been designed as the corporate culture. Culture is a hard skill but various soft skills also play a contributory role. The organisation's values are important. The leader has got to ensure that these are not deviated while buiding the corporate culture. The uncultured have no place in the corporate environment and, in my view, a good culture must be followed by everyone - top to bottom - for lasting success.

     
     
     
    • CJ Cullinane

    Very interesting article, I have to get this book. I believe the culture of any organization starts at recruiting, builds on living the culture (action) daily, and has a strong 'mission' that solidifies the organization.

    I think the Four Rs could turn out to be an effective tool for an organization. Kudos Dr. Heskett.

    Charlie

     
     
     
    • Don Mercer
    • CEO, Phalanx, Leadership Education Consulting Services

    An excellent article and I look forward to the book. I am a firm believer that to get from good to great you need to first get the culture right. The culture is the foundation upon which mission, values and all other words on the wall rest. The culture can be controlled to a sufficient extent to give positive life to any organization. In Follow to Lead (www.follow-to-lead.com) I have condensed years of practical, hands-on experience in the military, CIA and as CEO of various organizations and reading the research on organizational culture into a brief, nuggets only, book that can be used by organizations to affect their culture no matter what shape it is in now. Those in senior leadership positions, followers and consultants find it useful in their work. In my view organizations tend to emphasize leadership, leadership education and training, leadership development, etc. Few companies pay equal attention to their "followers" who are doing the real work every day. Follow to Lead provides a new mindset for organizations to affect their culture by looking at the timeless principles that make up a great follower. Those principles are codified in the "Followership Culture" which supports the organizational-unique cultural elements the organization wishes to implement. Great leaders are precious; great followers, priceless!