Insights

Why do some companies outlast and outperform their competitors while most don’t? Why is it that a few develop wide competitive advantages while most others don’t – even when the secrets of those competitive advantages are widely known?

One way to answer these questions is to understand what isn’t the right approach. Warren Buffett once said that what the wise do in the beginning, fools do in the end. One such idea that has been taken to its foolish extremes over the past few decades is the idea of shareholder value maximization over everything else. At its extreme, it leads to a significant shortening in the time horizons of a corporation’s shareholders and its managers.

Indeed, James Montier reported just such short-termism[1]. As Mr. Montier observed, “The life-span of an S&P 500 company has decreased from more than 26 years in 1971–1976 to close to 15 years in 2005–2010, and the average tenure of CEOs has shrunk from 10 years to six years.”

The past decade has also seen a significant shift in the profile of corporate shareholders, with the ownership profile increasingly shifting towards passive funds. One of the attributes of passive funds is that they afford much more liquidity to their shareholders. Consider that flows in funds in general, and ETFs in particular, are driven by near-term performances. For most ETFs, their market cap weighting process means that near-term stock price performances drive their investment allocations – the stronger the near term stock price performance, the larger the allocations.

Clearly, such short-termism isn’t in the best interest of the Corporations. So, is there an alternative approach that allows companies to succeed in the long term? We believe that answer to the questions we posed above lies in the organization’s culture. A corporate culture that prizes the long-term as against the short-term, at times, even at the expense of the short-term.

It starts with the company’s mission and vision statement, the statement of purpose, which lays the foundation for the business. An important element of that statement of purpose is that it should focus on building a business that will last for multiple generations and should permeate through the organization.

An important point about culture is that there is no uniform culture that works for all companies – you need different organizational behavior depending on the business model of the company. As Charlie Munger stated, “One solution fits all is not the way to go. All these cultures are different. The right culture for the Mayo Clinic is different from the right culture at a Hollywood movie studio. You can’t run all these places with a cookie-cutter solution.”

We view culture as a key intangible asset. In our investment research process, we look to understand the organizational behavior in light of the type of the competitive advantages that the business possesses. For example, when looking at Mission Critical businesses, we look for organizational culture that places innovation and customer servicing above all else. On the other hand, when evaluating Economies of Scale businesses, we look for cultures with razor sharp focus on costs.

In some of our next articles over the next few months, we will discuss a few case studies of businesses that in our opinion have built strong and effective cultures.

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1 https://eic.cfainstitute.org/2014/10/23/shareholder-value-maximization-the-dumbest-idea-in-the-world/