#46 When Culture is a competitive advantage
How a company's culture can help us overcome the challenge of "unknown unknowns"
Navigating the challenges of an uncertain and rapidly changing business landscape can be daunting, particularly when faced with the unknown. Silicon Valley Bank collapse was unexpected for most, the same as it was the Covid outbreak or many other events. In this post, we explore how a company's culture can provide shelter for our long-term investments.
But what is culture? We're not talking about the free snacks, ping-pong tables, or casual Fridays. We're talking about the values, beliefs, and behaviors that shape how employees work together and serve customers. And there's no one-size-fits-all formula. Culture is not static; it evolves over time as the business grows and faces new challenges.
“The real company values, as opposed to the nice‐sounding values,
are shown by who gets rewarded, promoted, or let go”
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One of the biggest challenges investors face is dealing with the unknowns. We can do all the research and analysis we want, but we can never be completely certain about how a company will perform in the future. There are simply too many variables and too many external factors that can impact a company's fortunes.
Last week I read an interesting post by
who made me think (link below). He wrote there are different types of unknowns, and understanding them can help us make more informed investment decisions.The first type is known unknowns. These are things that we should be able to identify with a little bit of research. For example, we can look at a company's financial statements and analyze its revenue growth, profit margins, and debt levels. We can also study the industry and its competitive dynamics to get a better understanding of the company's position in the market. This type of information is usually well captured by the market and reflected in the price of companies.
The second type is the inaccessible unknowns. These are things that we could potentially identify but don't have access to for whatever reason. For example, a company may have proprietary technology or trade secrets that are not publicly available. Or, the company may operate in a foreign country where it's difficult to get reliable information.
Finally, there are unknown unknowns. These are things that we could not reasonably identify or anticipate based on the knowledge that exists today. In other words, they are things we don't know that we don't know. This could be a major technological breakthrough that disrupts the industry, the sudden liquidation of a Silicon Valley bank, a natural disaster that impacts the company's operations, or a global pandemic that upends the economy.
Given these challenges, it's clear that investing is far from being a science. How do you deal with these unknowns in the long term? One word: CULTURE.
Why is culture important in investing? For starters, a company's culture can be a powerful driver of its success. A strong corporate culture can help attract and retain top talent, foster innovation and creativity, and promote a long-term mindset that focuses on sustainable growth rather than short-term gains.
Moreover, a company's culture can be a valuable margin of safety for investors. Never forget most of the intrinsic value of a company lies in the terminal value. If we believe that a company has a strong culture that has translated into superior financial performance, we can be more confident that it will be able to weather any challenges that come its way. In other words, a strong culture can be a competitive advantage that helps a company outperform its peers over the long run.
Of course, assessing a company's culture is easier said than done. Unlike financial metrics, culture is a somewhat intangible concept that can be difficult to measure and quantify. However, there are certain things that we can look for that may indicate a strong culture. We can study a company's history and track record to see how it has navigated past challenges and setbacks. Has it demonstrated resilience and adaptability in the face of adversity? Has it been able to innovate and reinvent itself when needed?
Like any competitive advantage, culture can disappear or be challenged by competitors. Culture can gradually disappear, not because of an attack from a competitor, but from within. Therefore, if the foundations are well laid, culture can become the ultimate competitive advantage.
The Mainfreight case: Ready, fire, aim
Mainfreight is a New Zealand-based logistics company that has been providing transportation and supply chain solutions since its inception in 1978. Over the years, Mainfreight has established itself as a global player in the industry with its relentless focus on customer satisfaction, and strong corporate culture.
One of the most unique aspects of Mainfreight is its strong company culture, which has been built on a set of core values that include integrity, teamwork, and a commitment to excellence. This culture is reflected in the company's approach to customer service, decentralization, weekly accountability, and responsibility for each branch's revenues and profits, etc.
Another important aspect of Mainfreight's success has been its ability to adapt to changing market conditions maintaining a long-term view when taking decisions.
I don't want to go into infinite details to demonstrate a superior culture that is reflected in the long-term health of the company's numbers that it has achieved over the decades.
What I've come to realize lately is that you don't need 100 hours of studying a company to see that you've found something different, something superior. Obviously, we may be facing a case of survivor bias, but in hindsight, it is not very difficult to understand that by reading Bezos' letters in 1997, we were facing something unusual. The same would happen when reading Mark Leonard in his early days, Buffett, or many others who exude a special aura when managing a business.
Some of the things that immediately caught my attention about Mainfreight:
Mainfreight uses a highly decentralized structure, where each branch is an independent profit center. This means that the company tracks the weekly profit and loss of each branch to monitor their financial performance. Branches produce a weekly profit and loss statement that is reviewed by senior leaders to identify trends and make decisions about resource allocation. Additionally, the company uses a range of metrics to monitor performance, allowing it to quickly identify issues and take corrective action. Mainfreight's approach reflects its commitment to decentralization and accountability, allowing it to operate efficiently while maintaining a focus on delivering high-quality logistics solutions.
Bruce Plested, the founder of Mainfreight, believes in a capitalist philosophy that involves sharing profits with employees to create a sense of ownership and accountability. Mainfreight has implemented a profit-sharing program based on a percentage of the company's net profit, distributed among employees based on their contribution to the company's success. Plested's philosophy emphasizes collaboration and shared success, treating employees as partners and driving motivation and productivity. Mainfreight's commitment to its employees and belief in their importance has built a strong corporate culture focused on excellence and innovation.
Don Braid, CEO, sees a stable and experienced board as the foundation of the 100-year vision. “The board and the company must have a commitment to each other. Short-term boards make weak, short-term decisions. Instead of buying property, they lease. Instead of getting the very best person, you end up with the next-best person. Whereas, if you are never thinking about selling and making your money that way, you are focused on making it a good business. You make a different style of decision, you make long-term decisions. And you treat your people as if they are going to be with you for a long period of time.”
And these are just some of the things you can see scratching the surface. I encourage you to take a look at the YouTube video at the bottom of the post. A whole corporate culture summarised in 15min.
The story of Mainfreight is not only one of success, but also one of the continuous mistakes and lessons learned over the past 45 years. They have faced the challenge of incomplete Due Diligence in many of their acquisitions, a mix of known unknowns, unaccessible unknowns, and unknown unknowns. They believed they could export their Kiwi culture intact to other regions like Australia, Europe, or the USA, among other challenges.
However, what sets them apart is how their culture tackles these errors and works to prevent their repetition. The management remains the same, allowing the business to evolve and learn from its mistakes. Continuously changing means starting from scratch, but with a consistent culture, Mainfreight has been able to thrive and overcome obstacles.
Common traits in unrelated cultures
Despite the vast differences that can exist between companies and industries, we have come to find certain commonalities among successful companies. They might tackle and solve things differently, but the areas of focus and greatness are quite similar:
1. Performance-driven culture
These organizations prioritize delivering results over adhering to rigid procedures or traditions and are constantly seeking ways to improve their operations and exceed customer expectations. For Amazon, this means a relentless focus on customer obsession and generating free cash flow in the long term. Mainfreight reviews its profit and loss statements on a weekly basis (“margin is what matters, not revenue”) at each of its branches, rejecting the traditional notion of annual budgets. Netflix similarly operates without budgets, instead prioritizing flexibility and adaptation in response to shifting market conditions. Meanwhile, Constellation Software's performance-driven culture is built around rigorous financial metrics like minimum hurdle rates and reinvestment capabilities, which guide the company's investment decisions and help ensure a strong return on investment.
By embracing a culture of simple metrics and continuous improvement and a focus on measurable results, these companies have been able to achieve exceptional success and thrive in highly competitive industries.
2. Autonomy is highly valued
Autonomy and decentralization are highly valued normally by these companies. They empower their subsidiaries/operating groups or branches to make their own strategic decisions and give them the autonomy to manage their own finances. This approach taps into the expertise and local knowledge of each business, which helps drive growth and profitability over the long term.
Constellation relies on capital allocation decisions to the operating groups or even business groups. This approach is designed to encourage innovation and entrepreneurial thinking within each business.
Amazon's "two-pizza team" ensures that teams are small and nimble, allowing them to work independently and make quick decisions. Each team operates with a high degree of autonomy, making decisions that are in the best interest of the customer and the company. Amazon encourages its employees to experiment with new ideas, even if they might fail. This experimentation mindset is facilitated by the company's decentralized structure, which allows individual teams to try new things without seeking approval from upper management. This approach has led to some of Amazon's most successful products, such as Amazon Web Services and the Amazon Echo.
Mainfreight seeks always to empower individuals to take decisions. They hire people to take decisions. If they make mistakes, just learn and do make it again. It is well-known that Buffett and Munger let their many subsidiaries operate on their own, with a minimum of centralized bureaucracy... Their trust is in people rather than process.
A company can not remain innovative and efficient without the correct decentralized structure in place. Centralized decision-making and planning simply don’t work and kill any degree of entrepreneurship. But is not easy to achieve. Many companies will claim they have a decentralized approach, but in many cases, no team will be ever able to approve anything after getting the approval from above…
3. Empower leadership styles
But autonomy doesn’t do magic by itself. It doesn’t work everywhere. Meritocracy is a fundamental principle for any successful organization. Hiring, rewarding, and promoting the best employees based on their performance and contributions are crucial to building a high-performing team.
However, this may seem simple and obvious, but it can be incredibly difficult to achieve. For instance, if a manager has an incredible candidate but fears that this person may take their job in a short amount of time, do you think they will hire them? How many companies do you know that incentivize this type of behavior to not occur?
Mainfreight has a unique approach to hiring new people. They believe in giving everyone a chance to understand the business by starting from the bottom and working their way up, even university postgraduates. They don’t even have job descriptions! You just joined the company. This approach helps employees develop a deep understanding of the company's operations and culture. By doing so, they are able to identify potential leaders who have the skills and drive to become successful managers. Mainfreight's hiring process is not just about finding the best candidates, but also about nurturing and developing them into future leaders.
Netflix makes sure that they hire the best people who are responsible and well-incentivized. They reward top performers and promote them accordingly, and they also encourage management to hire people who are even better than themselves.
Indeed, there is no one-size-fits-all approach when it comes to building a successful company culture. For instance, Netflix believes in paying their employees at the top of the market and letting them choose how much they want to link their economic destiny to the company's success. On the other hand, Mainfreight splits 10% of the net profit of each branch equally among team members. These different compensation models illustrate the importance of principles in creating a culture that fosters autonomy, meritocracy, and high performance. Ultimately, what matters most is that the compensation model aligns with the company's values and goals, and incentivizes employees to contribute to the company's success.
4. Constant adaptation and innovation
Companies are living organisms that face constant changes. These changes may include the emergence of a new competitor with disruptive technology, a shift in demand for a particular good, or an increase in prices of necessary input products.
Having flexibility and dynamism embedded in a company's culture is not a given. Far from it, it is something exceptional. I would dare to say that it is intimately related to the constant innovation capacity, and the ability to grow and seek new areas of expansion. However, all of this implies that mistakes will be made. Most companies are not prepared, adapted, or incentivized to make mistakes. Moreover, in many cultures, mistakes are associated with failure. The one who makes a mistake is a loser.
Furthermore, let us consider that a company with short-term goals has few inherent incentives to innovate or make mistakes.
When you have identified the common traits that these types of companies have, it is easier for you to recognize them in other new and less familiar ones. Extraordinary cultures are scarce.
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References:
Chan, D. (2023). Elements of Success in the Volaris Culture. Acquired Knowledge: A Volaris group magazine. Link
Keith, D. (2013). Ready, Fire, Aim: The Mainfreight Story: How a Kiwi freight company went global. Random House NZ.
MacNeil, C. (2023). Valuing the Unknowable. Investment Talk
Netflix (2009). Reference Guide on our Freedom & Responsibility Culture. Link
Multimedia:
Jeff Bender, CEO at Harris, one of the operating groups at Constellation Software: business and culture.
Reed Hastings, founder of Netflix: why culture matters.
Don Braid, CEO at Mainfreight: culture and “clear vision”.
Fantastic article with great points and examples... Mainfreight looks very interesting.
Thanks for sharing
This is excellent and captures much of what I have learned about installing and perpetuating an intentional culture over the past decades. The key is intention and the creation of systems whose primary purpose is to support and deliver those intentional outcomes. The most critical part is creating understanding about how “the great game of business” is played (financial transparency and autonomy to impact performance) and sharing the outcomes of the game. I learned a great deal from studying Ken Iverson’s work at Nucor captured in his book “Plain Talk”.