While many other things go into determining a successful investment, I have found an incredibly high correlation between a strong company culture, great investment outcomes and sustainable profit growth. So, what is the right approach to accurately measure culture? And how can investors use those findings to inform investment decisions?

Moving Together

Corporate culture and business success are intertwined. When I consider the healthiest cultures I’ve observed, there are two things of note:

1. Alignment on vision: The entire organization, from senior leaders to the most junior employees, understands what the company is trying to do.
2. Alignment on goals: The company understands what they are measuring, and the incentives used to achieve goals, which pull employees in the right direction.

Positive culture improves alignment throughout the company in ways that benefit the bottom line. Achieving alignment means that employees approach work not just as a job but as something they care about in some non-economic way. Organizations where junior employees are bought into the firm’s strategy are those where employees can make better decisions in the thousands of everyday actions that add up to the success of the enterprise. Success is made in settings where people take pride in their work and go beyond the requirements in their job descriptions – alignment doesn’t have to be more complicated than that.

We have all seen highly effective and aligned company cultures at work. As consumers, the difference between walking into a Chick-Fil-A compared to other fast-food establishments is palpable. The engagement of the average Chick-Fil-A employee often translates into more reliable food service and a positive experience for the customer. And while training and process certainly play a role, I would argue the biggest difference is corporate culture. This alignment increases revenue when people are taking these extra steps to support customers and the business. It reduces redundancies in terms of extra expenses as well, if you have an aligned and motivated culture, you don’t have to fill gaps with extra bodies.

Tying people’s compensation to measures of organizational success that they believe they can influence is also crucial. Some of my favorite transactions are when we buy orphaned divisions of larger companies. The day after the transaction, you can shift how people behave and what matters to them by realigning their incentive structure to support business objectives.

In one of the most successful investments I have seen, a junior IT professional pulled me aside after we bought the company and perfectly articulated why he thought our acquisition was a smart decision. This level of engagement showed the employee cared for his job in some non-economic way that helped the company well exceed expectations.

Conversely, I have seen plenty of well-positioned companies where talented executives flounder due to a lack of alignment. These organizations tend to have management that is divorced from the employee base. Often these management teams have physically separated themselves from the organization and fail to genuinely engage with their employee base.

Toxic cultures should be a big red flag for investors because they can be hard to fix. However, it’s not impossible. For one company I engaged with, bad culture spiraled as senior leaders isolated themselves from the rest of the company. What we found retrospectively was that most of the organization knew what the problems were, but they weren’t empowered to interact with senior management. We brought in a new leadership team and, in a symbolic gesture during a company-wide town hall, broke down the walls separating the executive suite. It was the jolt to get people back on board with changing ideas. You can reform these toxic cultures, but it requires a significant jolt to the organization to fix it.

Communication is Key

Achieving alignment starts with communication at the top of the organization and ends with everyone at all levels and functions buying in. Your team members generally know what needs to be done to achieve organizational success. As we saw in the example above, people are smart and were hired for a reason – leaders have to have a constant, open flow of ideas from every part of their organization.

I’ve seen the success of open communication in early-stage companies and recognize that alignment gets harder the larger the organization becomes. That’s because the distance between senior management and the people doing the work increases. One of the challenges companies don’t address as they grow is how they maintain the things that enabled the business to work when it was smaller.

However, some companies have managed to maintain this communication even beyond the walls of the organization itself. In the retail space, L Brands had a famous Monday meeting where they would bring all the merchants in the organization together and decide what products to order. They would involve suppliers in real-time to ensure closer alignment, which built an amazing set of relationships.

Years after L Brands began this meeting, business leaders are now recognizing the emerging need to have true partnerships rather than transactional relationships. There are so many success stories of organizations that have managed to do that. A lot of companies are trying to shrink the number of vendors they deal with so they can have more strategic partnerships.

Investors should be cognizant of the surrounding ecosystem of a company, including the extended network of suppliers, customers and other collaborators. It becomes a more symbiotic relationship when folks are viewed as partners and when communication is effective for this extended community.

Changing the Face of Work

We are entering a period that will be quite volatile across industries. Leaders need to have organizations that can adapt, address challenges and seize opportunities. They have to be more nimble than usual. If people aren’t motivated and incentivized properly, it will be hard for a company to adapt to changes – and this struggle will cause companies to underperform. Further, companies with positive cultures will be at a competitive advantage because they will also have lower turnover, especially for industries with high labor demands (e.g., those outside of technology and finance).

Conversely, other trends are indicative of a downshift in culture. Employment is becoming much more transactional, which is a detriment to culture and ultimately to the bottom line. Tenure can be an indicator of positive culture, but not on its own. It’s only useful when measured alongside engagement and alignment throughout the organization. It will get harder to build culture and maintain alignment, but it will also separate winners and losers. It will take leaders communicating and figuring out what we want to measure.

With the shift to hybrid work environments, many organizations have been able to coast on culture in the last couple of years. However, I fear things will eventually start to break down. Whether the fix means people move into office settings or finding solutions in hybrid environments, the hybridity we’ve seen in the last three years will force culture to become a more front-and-center issue. People are making it work (well, everyone says it’s working), but my concern is there is an increasing distance between employees and what matters.

Leaders need to be direct about what focus areas they are working on and how that will (or will not) change the strategy. That means a need for clarity, alignment and communication. For example, a lot of organizations have struggled to genuinely incorporate things like sustainability and diversity and more things that matter to employees, but good cultures are all about authenticity and incorporating these elements in a genuine manner. Further, leaders have to avoid just paying lip service to broader issues that aren’t reflective of where the company is heading.

When it comes to bringing culture to life, many leaders have gotten out of the habit of practicing those things that were important culturally before COVID. Those activities include town halls and company events that made people feel cared about in some non-economic way. Leaders need to find new ways to show employees they are authentically valued in hybrid environments.

Measure What Matters

The ability to accurately assess culture will lead to a competitive investing advantage. Investors need to proactively inquire if businesses measure culture (and how). They also need to stress test alignment with questions about engagement at the junior level, including if these employees can articulate what the company is trying to achieve.

Any good diligence effort needs direct conversation with staff-level employees. I’ve found 30 minutes of honest conversation with a sales force or warehouse team is often more valuable than weeks of analysis on historical financials. In a retail company, you know when you walk into stores where people are getting it right through conversations with store managers. Ask them about goals, what data they’re looking at to make sure they’re achieving them, if they can speak to the broader mission and if they’re connecting with peers. I saw this engagement in practice at Torrid, where managers were tracking the right data in-store and where employees really cared about customers and wanted them to have a positive experience.

There are ways to measure culture. A big part of it is surveying throughout the organization to ensure alignment. Often these surveys are massive and have a lot of noise, but simple, direct, more frequent measurements of engagement on a small number of topics can get better answers. It’s also important those survey results get looked at by senior management. Unfortunately, it’s just not happening.

That’s often because companies don’t use HR effectively. It’s frequently considered administrative rather than senior leadership. HR leaders are being told to do surveys, but the reports come back to HR and often end there. Business leaders must ensure that such surveys are getting into the hands of decision-makers who can effect change.

Investors need to assess and cultivate certain traits within their portfolio companies. That includes communication. Investors should also evaluate what the company is measuring, how frequently they are measuring it, if engagement is trending in the right direction, if junior employees understand the mission and if incentives are aligned to achieve that mission.

CEOs and Boards need to focus on how to build and measure culture. While there are many types of successful company cultures, the most effective tend to be ones where employees understand the mission of the organization, feel empowered to help support that mission and care in some non-economic way about their job.  Companies that can successfully align culture will unlock value in highly competitive industries, driving a competitive advantage in personnel and value creation to the bottom line.