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.

by Sean Silverthorne

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

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