An Overlooked Value Driver – Company Culture Alignment

[vc_row][vc_column][vc_column_text]Culture is often overlooked when firms are preparing for sale as well as when companies are searching for acquisitions. There is a higher likelihood of success in a sale and in a purchase when both cultures are in alignment as noted in the article below…

Guest Contributor: RS Wait, Chtd.
By: Scott T. Wait, CPA, AEP, and Mark A. Dayman, CPA, ABV,
CVA Originally Published in Value Examiner

What does company culture have to do with value? Valuation professionals have been taught that value is ultimately driven by the level, strength, and predictability of earnings and free cash flow, applied within the context of common valuation approaches.

However, a company’s culture—the shared values and practices of a company’s people—is one of the least understood but most critical value drivers. The Booz & Company annual study, “Why Culture Is Key” (Winter 2011), defined company culture as “the organization’s self-sustaining pattern of behaving, feeling, thinking, and believing. It trumps strategy and leadership.”

As an example, remember when Steve Jobs returned to Apple Computer? The “white knight” used his commitment to visionary products and design perfection to motivate employees as Apple revolutionized ways of delivering and listening to music and communicating and connecting with others.

Consider as well Louis V. Gerstner, Jr.’s turnaround of IBM, which by 1993 was the corporate equivalent of an ocean liner full of fiefdoms focused on building office machines. And that ocean liner essentially was Grow your business 2015 Issue 10 Page 3 rudderless and adrift: IBM was running out of cash, Gerstner later wrote in his book Who Says Elephants Can’t Dance? Over the next 19 years, IBM transformed itself into a more cooperative and highly profitable business, based on renewed leadership in the field of software as a service (SAAS). Once cash flow was stabilized, Gerstner focused on transforming the culture to optimize the long-term value of IBM. In Who Says Elephants Can’t Dance? Gerstner wrote that IBM’s culture reemphasized cooperation, fun, innovation, and results orientation to drive IBM’s overall company value to new heights.

The Booz study found critical links between culture and value. We used to think that R&D drove innovation and company value, but the Booz study emphasizes that “there is no statistical relationship between financial performance and innovation spending in terms of either total R&D dollars or R&D as a percentage of revenues.” Take Apple, as noted above: it consistently under spends its peers on R&D, but its results outperform its peers.

Businesses that have aligned cultures to innovation and strategy have a distinct performance advantage. The Booz study found that companies that highly align their cultures to strategic goals achieve higher rates of growth in both gross profit and enterprise value. Companies with highly aligned cultures generate 16.67 percent higher enterprise value based on five-year Compound Annual Growth Rate, CAGR compared with the average of all companies participating in the study.

And where do such companies focus their attention? Belying the belief that customer service died long in ago America, companies with perceived strong cultures focus on three key success factors: superior product performance, superior product quality, and aggressive customization of products to local markets and geographies.

Companies whose management teams have aligned their cultures to their company strategies also are employers of choice (and valued at a premium), because they have optimized product design, delivery, and customer services. Informed investors prefer to buy companies that strongly align their cultures to innovation, which routinely delivers higher profitability while also serving as a long-term “growth engine.”

In our business valuation and M&A consulting practices, we have seen a direct connection between a company culture of “engaged” employees and value. When working with potential buyers of company clients, such as private equity groups and strategic buyers, we seek to identify cultural factors that drive value.

Here are some questions that we typically use to identify the existence and scope of a strong corporate culture and its impact on a company’s value:

  1. Continual communication with customers drives customer loyalty, innovation, revenues, profits, and thereby value (higher economic benefits). Does the company regularly survey customers on the utility and quality of its products and services, especially in relation to alternative products and services and the customer’s emerging needs? Does the company have a history of taking action based on its customer surveys?
  2. A company that depends on a single owner for market, product, and operational success is headed for trouble and has limited value. Management depth builds value (higher economic benefits, lower specific company risk). Has the owner developed at least one layer of executive management sufficient to ensure that the owner can step away from the business?
  3. A company with a history of well-conceived and well executed business plans tends to realize lower business risk and better economic results. Does the company annually complete a strategic business planning session that involves input from all staff?
  4. Employee empowerment increases product and service performance and customer satisfaction in turn. Making every employee part of the “team” is critical. Some issues to consider:
  • Does the company have an established program to hire the best candidates?
  • Is there an effective plan for new employee orientation, and procedures with reality checks (the happy and sober realities of work environment) Does the company maintain a mentoring system to orient new employees with appropriately matched, seasoned employees?
  • Do all employees have clearly explained job responsibilities and rewards? Are employees trained and empowered to make decisions involving their work processes? For example, at most auto manufactures today, any single employee can stop a manufacturing line if he or she finds a defect in an auto on the line: that’s empowerment.

The message is clear: company culture drives value. Valuation, M&A, and exit strategy professionals must seek to understand company cultures, whether the assignment relates to a company’s general purposes, or for transition-related positioning.


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